UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

(Mark One)

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year EndedendedDecember 31, 2018
 December 31, 2016
or
 

or

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


Commission File Number
0-26850 

 

 

 

FIRST DEFIANCE FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

 

OHIO 34-1803915
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)
601 Clinton Street, Defiance, Ohio 43512
(Address of principal executive offices) (Zip code)

 

Registrant’s telephone number, including area code:(419) 782-5015

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock, Par Value $0.01 Per Share The NASDAQ Stock Market
(Title of Class) (Name of each exchange on which registered)

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes¨Nox

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes¨Nox

 

Indicate by check mark whether the Registrantregistrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YesxNo¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YesxNo¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’sthe registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.¨

 

Indicate by check mark whether the Registrantregistrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “accelerated filer”, “large accelerated filer”filer,” “accelerated filer,” “smaller reporting company,” and “smaller reporting“emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨Accelerated filer  xNon-accelerated filer  ¨Smaller reporting Company   ¨

Large accelerated filer¨Accelerated filer xNon-accelerated filer ¨Smaller reporting company ¨Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨Nox

 

The aggregate market value of the voting stock held by non-affiliates of the Registrantregistrant computed by reference to the average bid and ask price of such stock as of June 30, 20162018, was approximately $338.8$675.1 million.

 

As of February 20, 2017,January 31, 2019, there were issued and outstanding 8,985,38520,067,268 shares of the Registrant’sregistrant’s common stock.

 

Documents Incorporated by Reference

 

Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive Proxy Statement for the 20172019 Annual Shareholders’ Meeting.Meeting of the registrant’s shareholders.

 

 

 

 

First Defiance Financial Corp.

Annual Report on Form 10-K

 

Table of Contents

 

  Page
PART I  
Item 1.Business3
Item 1A.Risk Factors2325
Item 1B.Unresolved Staff Comments2833
Item 2.Properties2833
Item 3.Legal Proceedings3034
Item 4.Mine Safety Disclosures3034
   
PART II  
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities3034
Item 6.Selected Financial Data3336
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationOperations3437
Item 7A.Quantitative and Qualitative Disclosures About Market Risk5456
Item 8.Financial Statements and Supplementary Data5759
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure127130
Item 9A.Controls and Procedures127131
Item 9B.Other Information127131
   
PART III  
Item 10.Directors, Executive Officers and Corporate Governance127131
Item 11.Executive Compensation127131
Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters128132
Item 13.Certain Relationships and Related Transactions, and Director Independence128132
Item 14.Principal Accounting Fees and Services128132
   
PART IV  
Item 15.Exhibits, Financial Statement Schedules129133
Item 16.Form 10-K Summary133
   
SIGNATURES 130134

 

 - 2 - 

 

 

PART I

 

Item 1. Business

 

First Defiance Financial Corp. (“First Defiance” or “the Company”) is a unitary thrift holding company that, through its subsidiaries, First Federal Bank of the Midwest (“First Federal” or “the Bank”), First Insurance Group of the Midwest, Inc. (“First Insurance”), and First Defiance Risk Management Inc. (collectively, “the Subsidiaries”), focuses on traditional banking and property, and casualty, life and group health insurance products.

 

The Company’s philosophy is to grow and prosper, building long-term relationships based on top quality service, high ethical standards, and safe and sound assets. The Company operates as a locallylocally- oriented, community-based financial services organization, augmented by experienced, centralized support in select critical areas. The Company’s local market orientation is reflected in its market area management and local advisory boards, which are comprised of local business persons, professionals and other community representatives that assist area management in responding to local banking needs.

 

The Company’s operating objectives include expansion, diversification within its markets, growth of its fee-based income, and growth organically and through acquisitions of financial institutions, branches and financial services businesses. The Company seeks merger or acquisition partners that are culturally similar, have experienced management and possess either significant market area presence or have the potential for improved profitability through financial management, economies of scale and expanded services. The Company regularly evaluates merger and acquisition opportunities and conducts due diligence activities related to possible transactions with other financial institutions. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur. Acquisitions typically involve the payment of premiums over book and market values and, therefore, some dilution of the Company’s tangible book value and net income per common share may occur in any future transaction.

 

On August 23, 2016, First Defiance announced the execution of a definitive agreement (the “Agreement”) to acquire Commercial Bancshares, Inc. (“Commercial Bancshares”) and its wholly-owned subsidiary, the Commercial Savings Bank. Each Commercial Bancshares shareholder will receive 1.1808 shares of First Defiance common stock (“First Defiance Shares”) or $51.00 in cash, subject to total consideration being paid 80% in First Defiance Shares and 20% in cash as provided in the Agreement. Based on the twenty-day average closing price of First Defiance Shares of $43.19 ending August 22, 2016, the transaction is valued at approximately $63.0 million in the aggregate, including a cash payment of approximately $1.5 million to cancel outstanding options. On December 31, 2016, Commercial Bancshares had $356 million in assets, $297 million in loans and $314 million in deposits at its seven banking offices. The transaction closed on February 24, 2017.

At December 31, 2016,2018, the Company had consolidated assets of $2.48$3.2 billion, consolidated deposits of $1.98$2.6 billion, and consolidated stockholders’ equity of $293.0$399.6 million. The Company was incorporated in Ohio in June of 1995. Its principal executive offices are located at 601 Clinton Street, Defiance, Ohio 43512, and its telephone number is (419) 782-5015.

On June 22, 2018, the Company announced a stock split in the form of a share distribution of two common shares for each outstanding common share. The stock split was distributed on July 12, 2018, to shareholders of record as of July 2, 2018. All share and per share data in this Form 10-K have been adjusted and are reflective of the stock split.

 

First Defiance's website, www.fdef.com, contains a hyperlink under the Investor Relations section to EDGAR, where the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge as soon as reasonably practicable after First Defiance has filed the report with the United StateStates Securities and Exchange Commission (“SEC”).

- 3 -

 

The Subsidiaries

 

The Company’s core business operations are conducted through its Subsidiaries:subsidiaries:

 

First Federal Bank of the Midwest:First Federal is a federally chartered stock savings bank headquartered in Defiance, Ohio. It conducts operations through twenty-seventhirty-six full-service banking center offices in Allen, Defiance, Fulton, Hancock, Henry, Lucas, Marion, Ottawa, Paulding, Putnam, Seneca, Williams, Wood, and WoodWyandot counties in northwest and central Ohio, twothree full-service banking center offices in Allen County in northeast Indiana, five full-service banking center offices in Lenawee County in southeast Michigan and one commercial loan production office in Hilliard, OhioAnn Arbor, Michigan, that was approved in August 2016 to become a full-service branch. The Hilliard location is expected to open as a full-service branchopened late in the firstfourth quarter of 2017.

- 3 -

 

First Federal is primarily engaged in community banking. It attracts deposits from the general public through its offices and website, and uses those and other available sources of funds to originate residential real estate loans, commercial real estate loans, commercial loans, home improvement and home equity loans and consumer loans. In addition, First Federal invests in U.S. Treasury and federal government agency obligations, obligations of the State of Ohio and its political subdivisions, mortgage-backed securities that are issued by federal agencies, including real estate mortgage investment conduits (“REMICs”) and residential collateralized mortgage obligations (“CMOs”), and corporate bonds. First Federal’s deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”). First Federal is a member of the Federal Home Loan Bank (“FHLB”) System.

 

First Insurance Group of the Midwest: First Insurance is a wholly owned subsidiary of First Defiance. First Insurance is an insurance agency that conducts business throughthroughout First Federal’s Markets. The Maumee and Oregon, Ohio, offices locatedwere consolidated into a new office in the Defiance, Maumee, Oregon, Bryan, Lima and Bowling Green,Sylvania, Ohio, areas.in January 2018. First Insurance offers property and casualty insurance, life insurance and group health insurance.

 

First Defiance Risk Management: First Defiance Risk Management was incorporated on December 20, 2012, as a wholly-owned insurance company subsidiary of the Company to insure the Company and the Subsidiariesits subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount ofhelp minimize the risk among themselves.allocable to each participating insurer.

 

Business Strategy

 

First Defiance’s primary objective is to be a high-performing, community banking organization,community-focused financial institution, well regarded in its market areas. First Defiance accomplishes this through emphasis on local decision making and empowering its employees with tools and knowledge to serve its customers’ needs. First Defiance believes in a “Customer First” philosophy that is strengthened by its Mission & Vision and Core Values initiatives. First Defiance also has a tagline of “Better Together” as an indication of its commitment to local, responsive, personalized service. First Defiance believes this strategy results in greater customer loyalty and profitability through core relationships. First Defiance is focused on diversification of revenue sources and increased market penetration in areas where the growth potential exists for a balance between acquisition and organic growth. The primary elements of First Defiance’s business strategy are commercial banking, consumer banking, including the origination and sale of single-family residential loans, enhancement of fee income, wealth management and insurance sales, each united by a strong customer service culture throughout the organization. In the later part of 2017, the Company recognized the need to adapt its organization structure to meet certain future strategic objectives and to continue its past success. The Company believes that fully utilizing the strengths of its leadership team and a structure that supports strategic initiatives will enhance its ability to achieve even more objectives in the future. As such, the Company redefined its market areas to support strategies to enhance processes and efficiencies to support overall growth. The new structure includes three metro markets; Toledo, Ohio, Fort Wayne, Indiana, and Columbus, Ohio, and two legacy markets; Southern Market Area and Northern Market Area.

 

 - 4 - 

 

 

Commercial and Commercial Real Estate Lending -Commercial and commercial real estate lending have been an ongoing focus and a major component of First Federal’s success. First Federal provides primarily commercial real estate and commercial business loans with an emphasis on owner- occupied commercial real estate and commercial business lending, including a focus on the deposit balances that accompany these relationships. First Federal’s client base tends to be small to middle market customers with annual gross revenues generally between $1 million and $50 million. First Federal’s focus is also on securing multiple guarantors in addition to collateral where possible. These customers require First Federal to have a high degree of knowledge and understanding of their business in order to provide them with solutions to their financial needs. First Federal’s “Customer First” philosophy and culture complements this need of its clients. First Federal believes this personal service model differentiates First Federal from its competitors, particularly the larger regional institutions. First Federal offers a wide variety of products to support commercial clients including remote deposit capture and other cash management services. First Federal also believes that the small business customer is a strong market for First Federal. First Federal participates in many of the Small Business Administration lending programs. Maintaining a diversified portfolio with an emphasis on monitoring industry concentrations and reacting to changes in the credit characteristics of industries is an ongoing focus.

 

Consumer Banking -First Federal offers customers a full range of deposit and investment products including demand, checking, money market, certificates of deposits, Certificate of Deposit Account Registry Service (“CDARS”) and savings accounts. First Federal offers a full range of investment products through the wealth management department and a wide variety of consumer loan products, including residential mortgage loans, home equity loans, and installment loans. First Federal also offers online banking services, which include mobile banking, People Pay (“P2P”), online bill pay, and online bill-pay.account opening as well as the MoneyPass ATM Network offering access to our customers to over 32,000 ATMs nationwide without a surcharge fee.

 

Fee Income Development - Generation of fee income and the diversification of revenue sources are accomplished through the mortgage banking operation, First Insurance and the wealth management department as First Defiance seeks to reduce reliance on retail transaction fee income.

 

Deposit Growth - First Federal’s focus has been to grow core deposits with an emphasis on total relationship banking withfor both our retail and commercial customers. First Federal’s pricing strategy considers the whole relationship of the customer. First Federal continues to focus on increasing its market share in the communities it serves by providing quality products with extraordinary customer service, business development strategies and branch expansion. First Federal will look to grow its footprint in areas believed to further complement its overall market share and complement its strategy of being a high-performing community bank.

 

Asset Quality -Maintaining a strong credit culture is of the utmost importance to First Federal. First Federal has maintained a strong credit approval and review process that has allowed the Company to maintain a credit quality standard that balances the return with the risks of industry concentrations and loan types. First Federal is primarily a collateral lender with an emphasis on cash flow performance, while obtaining additional support from personal guarantees and secondary sources of repayment. First Federal has directed its attention to loan types and markets that it knows well and in which it has historically been successful. First Federal strives to have loan relationships that are well diversified in both size and industry, and monitors the overall trends in the portfolio to maintain its industry and loan type concentration targets. First Federal maintains a problem loan remediation process that focuses on detection and resolution. First Federal maintains a strong process of internal control that subjects the loan portfolio to periodic internal reviews as well as independent third-party loan review.

 

Expansion Opportunities - First Defiance believes it is well positioned to take advantage of acquisitions or other business opportunities in its market areas. First Defiance believes it has a track record of successfully accomplishing both acquisitions and de novo branching in its market area. This track record puts the Company in a solid position to enter or expand its business. First Defiance will continue to be disciplined as well as opportunistic in its approach to future acquisitions and de novo branching with a focus on its primary geographic market area, which it knows well, and has been competing in for a long period of time, as well as surrounding market areas.

 

- 5 -Securities

Securities

 

First Defiance’s securities portfolio is managed in accordance with a written policy adopted by the Board of Directors and administered by the Investment Committee. The Chief Financial Officer, of First Federal, Controller, of First Federal, and the Chief AdministrationExecutive Officer of First Federal can each approve transactions up to $3.0 million. Two of the three officers are required to approve transactions between $3.0 million and $5.0 million. All transactions in excess of $5.0 million must be approved by the Board of Directors.

 

- 5 -

First Defiance’s investment portfolio includes 6186 CMO issues totaling $63.0$101.5 million, all of which are fully amortizing securities. Management does not believe the risks associated with any of its CMO investments are significantly different from risks associated with other pass-through mortgage-backed securities. First Defiance did not have any off-balance sheet derivative securities at December 31, 2016.2018.

 

Management determines the appropriate classification of debtFirst Defiance’s securities at the time of purchase. Debt securities areportfolio is classified as held-to-maturity when First Defiance has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities noteither “available-for-sale” or “held-to-maturity.”  Securities classified as held-to-maturity“available-for-sale” may be sold prior to maturity due to changes in interest rates, prepayment risks, and equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value.availability of alternative investments, or to meet the Company’s liquidity needs.

 

The carrying value of securities at December 31, 20162018, by contractual maturity is shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

 

 Contractually Maturing  Total  Contractually Maturing  Total 
    Weighted     Weighted     Weighted     Weighted          Weighted     Weighted     Weighted     Weighted      
 Under 1 Average 1 - 5 Average 6-10 Average Over 10 Average       Under 1 Average 1 - 5 Average 6-10 Average Over 10 Average      
 Year  Rate  Years  Rate  Years  Rate  Years  Rate  Amount  Yield  Year  Rate %  Years  Rate %  Years  Rate %  Years  Rate %  Amount  Yield 
 (Dollars in Thousands)  (Dollars in Thousands) 
Mortgage-backed securities $8,737   3.20% $32,915   3.14% $23,769   3.07% $14,639   3.03% $80,060   3.11% $10,089   3.22  $31,531   3.20  $22,882   3.15  $11,715   3.15  $76,217   3.12 
CMOs  9,414   2.97   30,164   2.87   20,944   2.78   3,429   2.79   63,951   2.85 
CMOs - residential  15,941   3.29   51,402   3.29   32,464   3.25   4,618   3.31   104,425   3.12 
U.S. government and federal agency obligations  -   -   2,000   1.50   2,000   2.00   -   -   4,000   1.75   -   -   519   2.00   2,000   3.00   -   -   2,519   2.00 
Obligations of states and political subdivisions (1)  578   1.56   9,923   3.69   36,202   3.72   39,345   3.43   86,048   3.58   802   4.07   9,528   3.31   32,689   3.61   56,805   3.38   99,824   3.55 
Corporate bonds  -   -   10,020   1.79   2,899   2.06   -   -   12,919   1.85   -   -   12,910   3.48   -   -   -   -   12,910   2.36 
Total $18,729      $85,022      $85,814      $57,413      $246,978      $26,832      $105,890      $90,035      $73,138      $295,895     
Unamortized premiums/ (discounts)                                  3,422                                       1,312     
Unrealized gain on securities available for sale                                  776     
Unrealized gain on securities available for sale and unrecognized gain on held to maturity                                  (2,605)    
Total                                 $251,176                                      $294,602     

 

(1)Tax exempt yield based on effective tax rate of 35%21%. Actual coupon rate is approximately equal to the weighted average rate disclosed in the table times 65%79%.

 

 - 6 - 

 

 

The carrying value of investment securities is as follows:

 

  December 31 
  2016  2015  2014 
  (In Thousands) 
Available-for-sale securities:            
Obligations of U.S. government corporations and agencies $3,915  $2,994  $980 
Obligations of state and political subdivisions  88,043   90,389   88,532 
CMOs, REMICS and mortgage-backed securities  146,019   138,074   142,816 
Trust preferred stock and preferred stock  2   1   1 
Corporate bonds  13,013   4,977   6,992 
Total $250,992  $236,435  $239,321 
             
Held-to-maturity securities:            
Mortgage-backed securities $91  $119  $158 
Obligations of state and political subdivisions  93   124   155 
Total $184  $243  $313 

  December 31 
  2018  2017  2016 
  (In Thousands) 
Available-for-sale securities:            
Obligations of U.S. government corporations and agencies $2,503  $508  $3,915 
Obligations of state and political subdivisions  99,887   92,828   88,043 
CMOs - residential, REMICS and mortgage-backed securities  178,880   154,210   146,019 
Trust preferred stock and preferred stock  -   1   2 
Corporate bonds  12,806   13,103   13,013 
Total $294,076  $260,650  $250,992 
             
Held-to-maturity securities:            
Mortgage-backed securities $51  $68  $91 
Obligations of state and political subdivisions  475   580   93 
Total $526  $648  $184 

 

For additional information regarding First Defiance’s investment portfolio, refer to Note 5 – Investment Securities to the Consolidated Financial Statements.

 

Interest-Bearing Deposits

 

The Company had $46.0$43.0 million and $41.0$55.0 million in overnight investments at the Federal Reserve at December 31, 20162018 and 2015,2017, respectively, which amount is included in interest-bearing deposits. First Defiance had interest-earning deposits inat the FHLB of Cincinnati and other financial institutions amounting to $1.8$1.7 million and $1.6$2.0 million at December 31, 20162018 and 2015,2017, respectively.

 

Residential Loan Servicing Activities

 

Servicing mortgage loans for investors involves a contractual right to receive a fee for processing and administering loan payments on mortgage loans that are not owned by the Company and are not included on the Company’s balance sheet. This processing involves collecting monthly mortgage payments on behalf of investors, reporting information to those investors on a monthly basis and maintaining custodial escrow accounts for the payment of principal and interest to investors and property taxes and insurance premiums on behalf of borrowers. At December 31, 2016,2018, First Federal serviced 14,35014,606 loans totaling $1.37 billion.$1.41 billion of principal. The vast majority of the loans serviced for others are fixed rate conventional mortgage loans. The Company primarily sells its loans to, and then services for, Freddie Mac, Fannie Mae and FHLB. At December 31, 2016, 64.82%2018, 66.40%, 34.31%32.70% and 0.81%0.85% of the Company’s sold loans were to Freddie Mac, Fannie Mae and FHLB, respectively.

 

As compensation for its mortgage servicing activities, the Company receives servicing fees, usually approximating 0.25% per annum of the loan balances serviced, plus any late charges collected from delinquent borrowers and other fees incidental to the services provided. In the event of a default by the borrower, the Company receives no servicing fees until the default is cured.

 

- 7 -

The following table sets forth certain information regarding the number and aggregate principal balance of the mortgage loans serviced by the Company, including both fixed and adjustable rate loans, at various interest rates:

 

  December 31 
  2016  2015  2014 
        Percentage        Percentage        Percentage 
  Number  Aggregate  of Aggregate  Number  Aggregate  of Aggregate  Number  Aggregate  of Aggregate 
  of  Principal  Principal  of  Principal  Principal  of  Principal  Principal 
Rate Loans  Balance  Balance  Loans  Balance  Balance  Loans  Balance  Balance 
  (Dollars in Thousands) 
                            
Less than 3.00%  2,191  $225,328   16.42%  1,836  $188,916   14.06%  1,807  $194,998   14.48%
3.00% -3.99%  6,279   682,157   49.72   5,606   603,875   44.94   4,985   544,117   40.41 
4.00% -4.99%  3,551   332,023   24.20   3,924   379,917   28.28   3,952   386,949   28.73 
5.00% - 5.99%  1,405   83,775   6.11   1,761   110,616   8.23   2,200   147,057   10.92 
6.00% - 6.99%  749   41,055   2.99   922   50,937   3.79   1,086   62,379   4.63 
7.00% and over  175   7,680   0.56   209   9,461   0.70   237   11,138   0.83 
Total  14,350  $1,372,018   100.00%  14,258  $1,343,722   100.00%  14,267  $1,346,638   100.00%
- 7 -

  December 31    
  2018  2017  2016 
        Percentage        Percentage        Percentage 
  Number  Aggregate  of Aggregate  Number  Aggregate  of Aggregate  Number  Aggregate  of Aggregate 
  of  Principal  Principal  of  Principal  Principal  of  Principal  Principal 
Rate Loans  Balance  Balance  Loans  Balance  Balance  Loans  Balance  Balance 
  (Dollars in Thousands) 
                            
Less than 3.00%  1,843  $158,038   11.19%  2,024  $189,700   13.69%  2,191  $225,328   16.42%
3.00% -3.99%  6,218   647,182   45.85   6,598   710,084   51.22   6,279   682,157   49.72 
4.00% -4.99%  4,746   495,217   35.08   3,919   377,821   27.26   3,551   332,023   24.20 
5.00% - 5.99%  1,096   77,154   5.46   1,122   68,423   4.94   1,405   83,775   6.11 
6.00% - 6.99%  557   28,672   2.03   626   33,658   2.43   749   41,055   2.99 
7.00% and over  146   5,570   0.39   158   6,382   0.46   175   7,680   0.56 
Total  14,606  $1,411,833   100.00%  14,447  $1,386,068   100.00%  14,350  $1,372,018   100.00%

 

Loan servicing fees decrease as the principal balance on the outstanding loan decreases and as the remaining time to maturity of the loan shortens.

 

The following table sets forth certain information regarding the remaining maturity of the mortgage loans serviced by the Company as of the dates shown.

 

 December 31     December 31    
 2016  2015  2014  2018  2017  2016 
Maturity Number
of Loans
  % of
Number
of Loans
  Unpaid
Principal
Amount
  % of
Unpaid
Principal
Amount
  Number
of Loans
  % of
Number
of Loans
  Unpaid
Principal
Amount
  % of
Unpaid
Principal
Amount
  Number
of Loans
  % of
Number
of Loans
  Unpaid
Principal
Amount
  % of
Unpaid
Principal
Amount
  Number
of Loans
  % of
Number
 of Loans
  Unpaid
Principal
Amount
  % of
Unpaid
Principal
Amount
  Number
of Loans
  % of
Number
of Loans
  Unpaid
Principal
Amount
  % of
Unpaid
Principal
Amount
  Number
of Loans
  % of
Number
of Loans
  Unpaid
Principal
Amount
  % of
Unpaid
Principal
Amount
 
 (Dollars in Thousands)  (Dollars in Thousands) 
                                                  
1–5 years  529   3.69% $7,432   0.54%  680   4.77% $10,801   0.80%  810   5.67% $15,932   1.18%  439   3.01% $10,212   0.72%  444   3.07% $8,346   0.60%  529   3.69% $7,432   0.54%
6–10 years  1,784   12.43   102,132   7.44   1,563   10.97   89,364   6.65   1,204   8.44   64,979   4.83   2,777   19.01   172,130   12.19   2,557   17.70   162,190   11.70   1,784   12.43   102,132   7.44 
11–15 years  3,671   25.58   343,750   25.05   3,759   26.36   349,986   26.05   4,082   28.61   385,409   28.62   2,707   18.53   249,274   17.66   3,012   20.85   278,655   20.10   3,671   25.58   343,750   25.05 
16–20 years  1,526   10.63   135,540   9.88   1,635   11.47   144,249   10.74   1,720   12.06   155,783   11.57   1,049   7.18   93,775   6.64   1,258   8.71   109,300   7.89   1,526   10.63   135,540   9.88 
21–25 years  1,846   12.86   169,496   12.35   1,833   12.85   169,889   12.64   1,575   11.04   143,062   10.62   2,915   19.96   299,815   21.24   2,460   17.03   248,919   17.96   1,846   12.86   169,496   12.35 
More than 25 years  4,994   34.81   613,668   44.74   4,788   33.58   579,433   43.12   4,876   34.18   581,473   43.18   4,719   32.31   586,627   41.55   4,716   32.64   578,658   41.75   4,994   34.81   613,668   44.74 
Total  14,350   100.00% $1,372,018   100.00%  14,258   100.00% $1,343,722   100.00%  14,267   100.00% $1,346,638   100.00%  14,606   100.00% $1,411,833   100.00%  14,447   100.00% $1,386,068   100.00%  14,350   100.00% $1,372,018   100.00%

 

Lending Activities

 

GeneralA savings bank generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable collateral. Real estate is not considered “readily marketable collateral.” Certain types of loans are not subject to these limits. In applying these limits, loans to certain borrowers may be aggregated. Notwithstanding the specified limits, a savings bank may lend to one borrower up to $500,000 “for any purpose.” At December 31, 2016,2018, First Federal’s limit on loans-to-one borrower was $40.3$52.6 million and its five largest loans (including available lines of credit) or groups of loans to one borrower, including related entities, were $23.6$30.5 million, $23.3$28.4 million, $23.1$28.2 million, $23.1$26.8 million and $22.9$26.6 million. All of these loans or groups of loans were performing in accordance with their terms at December 31, 2016.2018.

 

Loan Portfolio CompositionThe net increase in net loans receivable over the prior year was $137.8$189.7 million, $154.8$407.4 million (including $285.4 million acquired from CSB) and $66.5$137.8 million at December 31, 2016, 2015,2018, 2017, and 2014,2016, respectively. The loan portfolio contains no foreign loans. The Company’s loan portfolio is concentrated geographically in the northwest and central Ohio, northeast Indiana, central Ohio and southeast Michigan market areas. Management has identified lending for income generating rental properties as an industry concentration. Total loans for income generating rental property totaled $687.5$982.5 million at December 31, 2016,2018, which represents 33.8%37.9% of the Company’s loan portfolio.

 

 - 8 - 

 

 

The following table sets forth the composition of the Company’s loan portfolio by type of loan at the dates indicated.

 

 December 31  December 31 
 2016  2015  2014  2013  2012  2018  2017  2016  2015  2014 
 Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  %  Amount  % 
 (Dollars in Thousands)  (Dollars in Thousands) 
Real estate:                                                                                
1-4 family residential $207,550   10.2% $205,330   11.0% $206,437   12.2% $195,752   12.2% $200,826   13.0% $322,686   12.1% $274,862   11.1% $207,550   10.2% $205,330   11.0% $206,437   12.2%
Multi-family residential  196,983   9.7   167,558   9.0   156,530   9.3   148,952   9.2   122,275   7.9   278,358   10.4   248,092   10.1   196,983   9.7   167,558   9.0   156,530   9.3 
Commercial real estate  843,579   41.5   780,870   41.8   683,958   40.6   670,666   41.6   675,110   43.7   1,126,452   42.3   987,129   40.0   843,579   41.5   780,870   41.8   683,958   40.6 
Construction  182,886   9.0   163,877   8.7   112,385   6.7   86,058   5.3   37,788   2.5   265,772   10.0   265,476   10.8   182,886   9.0   163,877   8.7   112,385   6.7 
Total real estate loans  1,430,998   70.4   1,317,635   70.5   1,159,310   68.8   1,101,428   68.3   1,035,999   67.1   1,993,268   74.8   1,775,559   72.0   1,430,998   70.4   1,317,635   70.5   1,159,310   68.8 
                                                                                
Other:                                                                                
                                                                                
Commercial  469,055   23.0   419,349   22.4   399,730   23.7   388,236   24.1   383,817   24.9   509,577   19.1   526,142   21.3   469,055   23.0   419,349   22.4   399,730   23.7 
Home equity and improvement  118,429   5.8   116,962   6.2   111,813   6.6   106,930   6.6   108,718   7.0   128,152   4.8   135,457   5.5   118,429   5.8   116,962   6.2   111,813   6.6 
Consumer finance  16,680   0.8   16,281   0.9   15,466   0.9   16,902   1.0   15,936   1.0   34,405   1.3   29,109   1.2   16,680   0.8   16,281   0.9   15,466   0.9 
  604,164   29.6   552,592   29.5   527,009   31.2   512,068   31.7   508,471   32.9   672,134   25.2   690,708   28.0   604,164   29.6   552,592   29.5   527,009   31.2 
Total loans  2,035,162   100.0%  1,870,227   100.0%  1,686,319   100.0%  1,613,496   100.0%  1,544,470   100.0%  2,665,402   100.0%  2,466,267   100.0%  2,035,162   100.0%  1,870,227   100.0%  1,686,319   100.0%
Less:                                                                                
Undisbursed loan funds  93,355       66,902       38,653       32,290       18,478       123,293       115,972       93,355       66,902       38,653     
Net deferred loan origination fees  1,320       1,108       880       758       735       2,070       1,582       1,320       1,108       880     
Allowance for loan losses  25,884       25,382       24,766       24,950       26,711       28,331       26,683       25,884       25,382       24,766     
Net loans $1,914,603      $1,776,835      $1,622,020      $1,555,498      $1,498,546      $2,511,708      $2,322,030      $1,914,603      $1,776,835      $1,622,020     

 

In addition to the loans reported above, First Defiance had $6.6 million, $10.4 million, $9.6 million, $5.5 million, $4.5 million, $9.1 million, and $22.1$4.5 million in loans classified as held for sale at December 31, 2018, 2017, 2016, 2015 2014, 2013 and 2012,2014, respectively. The fair value of such loans, which are all single-family residential mortgage loans, approximated their carrying value for all years presented.

 

Contractual Principal, Repayments and Interest RatesThe following table sets forth certain information at December 31, 20162018, regarding the dollar amount of gross loans maturing in First Defiance’s portfolio, based on the contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.

 

 Years After December 31, 2016  Years After December 31, 2018 
 Due Less
than 1
 Due 1-2 Due 3-5 Due 5-10 Due 10-15 Due 15+ Total  Due Less
than 1
  Due 1-2  Due 3-5 Due 5-10  Due 10-15  Due 15+  Total 
 (In Thousands)  (In Thousands) 
Real estate $471,363  $164,604  $608,344  $88,086  $31,425  $67,176  $1,430,998  $559,270  $241,509  $902,900  $141,645  $56,473  $91,471  $1,993,268 
Other loans:                                                        
Commercial  316,760   50,152   94,636   7,507   -   -   469,055   342,026   60,473   100,384   4,714   900   1,080   509,577 
Home equity and improvement  109,651   2,410   4,044   1,452   425   447   118,429   113,673   2,455   5,921   2,924   1,373   1,806   128,152 
Consumer finance  6,726   3,531   6,194   223   6   -   16,680   17,194   6,183   9,887   1,141   -   -   34,405 
Total $904,500  $220,697  $713,218  $97,268  $31,856  $67,623  $2,035,162  $1,032,163  $310,620  $1,019,092  $150,424  $58,746  $94,357  $2,665,402 

 

The schedule above does not reflect the actual life of the Company’s loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which give First Defiance the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid.

 

- 9 -

The following table sets forth the dollar amount of gross loans due after one year from December 31, 20162018, which havehas fixed interest rates or which have floating or adjustable interest rates.

 

     Floating or    
  Fixed  Adjustable    
  Rates  Rates  Total 
  (In Thousands) 
          
Real estate $289,578  $670,057  $959,635 
Commercial  114,463   37,832   152,295 
Other  17,602   1,130   18,732 
  $421,643  $709,019  $1,130,662 
- 9 -

     Floating or    
  Fixed  Adjustable    
  Rates  Rates  Total 
  (In Thousands) 
          
Real estate $483,202  $950,796  $1,433,998 
Commercial  105,171   62,380   167,551 
Other  30,189   1,501   31,690 
  $618,562  $1,014,677  $1,633,239 

 

Originations, Purchases and Sales of LoansThe lending activities of First Federal are subject to the written, non-discriminatory underwriting standards and loan origination procedures established by the Board of Directors and management. Loan originations are obtained from a variety of sources, including referrals from existing customers, real estate brokers, developers and builders, newspaper, internet and radio advertising and walk-in customers.

 

First Federal’s loan approval process for all types of loans is intended to assess the borrower’s ability to repay the loan, the viability of the loan and the adequacy of the value of the collateral that will secure the loan.

 

A commercial loan application is first reviewed by a commercial lender and underwritten by one of thea commercial credit analyst. All loan officers, who may approve credits within their lending limit. Another loan officer with limits sufficient to cover the exposure must approve credits exceeding an individual’s lending limit. All credits which exceed $100,000 in aggregate exposurerequests must be presented for review or approval to the Senior Loan Committee comprised of senior lending personnel. Creditsa Regional Credit Officer. Loans which exceed $1,000,000 must then be presented to the Chief Credit Officer or Credit Administration Officer for approval. These two positions can also approve loans up to $2,000,000 individually or $4,000,000 when using their authority concurrently. Any loan in aggregate exposureexcess of these limits must be presented for approval to the Executive Loan Committee.

 

Residential mortgage applications are accepted by retail lenders or branch managers, who utilize an automated underwriting system to review the loan request. First Federal also receives mortgage applications via an online residential mortgage origination system. A final approval of all residential mortgage applications is made by a member of a centralized underwriting staff within their designated lending limits. Loan requests in excess or outside an individual underwriter’s limit are approved by the Senior Loan Committeea Regional or Chief Credit Officer and, if necessary, by the Executive Loan Committee.

 

Retail lenders and branch managers are authorized to originate and approve direct consumer loan requests that are within policy guidelines and within the lender’s approved lending limit. Loans in excess of the lender’s approved lending limit may be approved by retail lending managers up to their approved lending limit. Loans in excess of the retail lending manager’s authorized lending limit or outside of policy must be approved by the Senior Loan Committeea Regional or Chief Credit Officer and, if necessary, by the Executive Loan Committee. Indirect consumer loans originated by auto dealers are underwritten and approved by a designated underwriter in accordance with Company policy and lending limits.

 

First DefianceFederal offers adjustable-rate loans in order to decrease the vulnerability of its operations to changes in interest rates. The demand for adjustable-rate loans in First Defiance’sFederal’s primary market area has been a function of several factors, including customer preference, the level of interest rates, the expectations of changes in the level of interest rates and the difference between the interest rates offered for fixed-rate loans and adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate residential loans that can be originated at any time is largely determined by the demand for each in a competitive environment.

 

Adjustable-rate loans represented 22.0% of First Federal’s total originations of one-to-four family residential mortgage loans in 2018 compared to 9.9% and 10.8% during 2017 and 2016, respectively.

 - 10 - 

 

Adjustable-rate loans represented 10.8% of First Defiance’s total originations of one-to-four family residential mortgage loans in 2016 compared to 10.3% and 11.9% during 2015 and 2014, respectively.

 

Adjustable-rate loans decrease the risks associated with changes in interest rates, but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.

 

The following table shows total loans originated, loan reductions, and the net increase in First Defiance’sFederal’s total loans and loans held for sale during the periods indicated:

 

 Years Ended December 31  Years Ended December 31 
 2016  2015  2014  2018  2017  2016 
 (In Thousands)  (In Thousands) 
Loan originations:                        
1-4 family residential $294,307  $241,658  $173,301  $282,109  $240,921  $294,307 
Multi-family residential  59,957   44,352   46,181   70,665   74,342   59,957 
Commercial real estate  166,437   241,969   159,959   279,251   181,289   166,437 
Construction  138,553   116,224   66,264   184,631   205,088   138,553 
Commercial  389,037   465,543   524,073   186,943   219,588   389,037 
Home equity and improvement  56,816   54,676   45,934   58,918   68,856   56,816 
Consumer finance  10,426   10,235   10,632   22,260   15,185   10,426 
Total loans originated  1,115,533   1,174,657   1,026,344   1,084,777   1,005,269   1,115,533 
Loans acquired in acquisitions:  -   285,448   - 
Loans purchased:  822   -   16,594   -   11,476   822 
Loan reductions:                        
Loan pay-offs  232,302   265,311   219,446   335,738   350,971   232,302 
Loans sold  282,589   231,067   176,381   236,598   231,073   282,589 
Periodic principal repayments  432,445   493,383   578,873   317,128   288,215   432,445 
  947,336   989,761   974,700   889,464   870,259   947,336 
Net increase in total loans and loans held for sale $169,019  $184,896  $68,238  $195,313  $431,934  $169,019 

 

Asset Quality

 

First Defiance’s credit policy establishes guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to ensure sound credit decisions. First Defiance’s credit policies and review procedures are meant to minimize the risk and uncertainties inherent in lending. In following the policies and procedures, management must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur because of changing economic conditions.

 

Delinquent Loans The following table sets forth information concerning delinquent loans at December 31, 2016,2018, in dollar amount and as a percentage of First Defiance’s total loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts that are past due.

 

  30 to 59 Days  60 to 89 Days  90 Days and Over  Total 
  Amount  Percentage  Amount  Percentage  Amount  Percentage  Amount  Percentage 
  (Dollars in Thousands) 
                         
1-4 family residential real estate $946   0.04% $993   0.04% $1,571   0.06% $3,510   0.14%
Multi- family residential  -   0.00   -   0.00   -   0.00   -   0.00 
Commercial real estate  130   0.00   417   0.02   3,008   0.11   3,555   0.13 
Construction  -   0.00   -   0.00   -   0.00   -   0.00 
Commercial  297   0.01   53   0.00   4,073   0.15   4,423   0.16 
Home equity and improvement  1,427   0.05   144   0.01   90   0.00   1,661   0.06 
Consumer finance  133   0.00   76   0.00   96   0.00   305   0.01 
Total $2,933   0.10% $1,683   0.07% $8,838   0.32% $13,454   0.50%

 - 11 - 

 

 

  30 to 59 Days  60 to 89 Days  90 Days and Over  Total 
  Amount  Percentage  Amount  Percentage  Amount  Percentage  Amount  Percentage 
  (Dollars in Thousands) 
                         
1-4 family residential real estate $221   0.01% $1,142   0.06% $608   0.03% $1,971   0.10%
Multi-  family residential  -   0.00   -   0.00   -   0.00   -   0.00 
Commercial real estate  159   0.01   16   0.00   2,072   0.10   2,247   0.11 
Construction  -   0.00   -   0.00   -   0.00   -   0.00 
Commercial  23   0.00   10   0.00   403   0.02   436   0.02 
Home Equity and Improvement  1,115   0.05   174   0.01   254   0.02   1,543   0.08 
Consumer Finance  85   0.01   69   0.00   78   0.00   232   0.01 
Total $1,603   0.08% $1,411   0.07% $3,415   0.17% $6,429   0.32%

Overall, the level of delinquencies at December 31, 2016 decreased2018, declined slightly from the levels at December 31, 2015,2017, when First Defiance reported that 0.64%0.53% of its outstanding loans were at least 30 days delinquent. The level of total loans 90 or more days delinquent has decreasedincreased to 0.17%0.32% at December 31, 20162018, from 0.39%0.20% at December 31, 2015.2017. The level of total loans 60-89 days delinquent decreased to 0.07% at December 31, 20162018, from 0.13%0.12% at December 31, 2015.2017. The level of loans that were 30 to 59 days past due decreased to 0.08%0.10% at December 31, 20162018, from 0.12%0.21% at December 31, 2015.2017. Management has assessed the collectability of all loans that are 90 days or more delinquent as part of its procedures in establishing the allowance for loan losses.

 

NonperformingNon-performing AssetsAll loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collectability of additional interest is not expected. Generally, First Defiance places all loans more than 90 days past due on non-accrual status. First Defiance also places loans on non-accrual status when the loan is paying as agreed but the Company believes the financial condition of the borrower is such that this classification is warranted. When a loan is placed on non-accrual status, total unpaid interest accrued to date is reversed. Subsequent payments are generally applied to the outstanding principal balance but may be recorded as interest income, depending on the assessment of the ultimate collectability of the loan. First Defiance considers that a loan is impaired when, based on current information and events, it is probable that it will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the loan agreement. First Defiance measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral, if collateral dependent. If the estimated recoverability of the impaired loan is less than the recorded investment, First Defiance will recognize impairment by allocating a portion of the allowance for loan losses on cash flow dependent loans and by charging off the deficiency on collateral dependent loans.

 

Loans originated by First Federal having principal balances of $27.4$45.8 million, $41.9$56.3 million and $48.9$27.4 million were considered impaired as of December 31, 2018, 2017 and 2016, 2015 and 2014, respectively. The decrease in impaired loans from 2014 to 2016 is due to a continued concerted effort by management and the lending staff to work specific credits out of the Bank or back to performing status. These amounts of impaired loans exclude large groups of small-balance homogeneous loans that are collectively evaluated for impairment such as residential mortgage, consumer installment and credit card loans, except for those classified as troubled debt restructurings. There was $1.7$1.8 million of interest received and recorded in income during 20162018 related to impaired loans. There was $1.3$1.4 million and $1.6$1.7 million recorded in 20152017 and 2014,2016, respectively. Unrecorded interest income based on the loan’s contractual terms on these impaired loans and all non-performing loans in 2018, 2017 and 2016 2015 and 2014 was $1.2$1.1 million, $1.5$1.1 million, and $1.2 million, respectively. The average recorded investment in impaired loans during 2016, 20152018, 2017 and 20142016 (excluding loans accounted for under FASB ASC Topic 310 Subtopic 30) was $32.8$49.2 million, $51.8$47.4 million and $50.3$32.8 million, respectively. The total allowance for loan losses related to these loans was $0.6 million, $0.8 million, $0.4 million, and $1.3$0.8 million at December 31, 2018, 2017 and 2016, 2015 and 2014, respectively.

- 12 -

 

Real estate acquired by foreclosure is classified as real estate owned until such time as it is sold. First Defiance also repossesses other assets securing loans, consisting primarily of automobiles. When such property is acquired it is recorded at fair value less cost to sell. Costs relating to development and improvement of property are capitalized, whereas costs relating to holding the property are expensed. Valuations are periodically performed by management and a write-down of the value is recorded with a corresponding charge to operations if it is determined that the carrying value of property exceeds its estimated net realizable value. During 2016,2018, First Defiance recognized $74,000$552,000 of expense related to write-downs in value of real estate acquired by foreclosure.foreclosure or acquisition. The balance of real estate owned at December 31, 20162018, was $455,000.$1.2 million. During 2017, there was $20,000 of expense related to write-downs in fair value of real estate acquired by foreclosure or acquisition. The balance of real estate owned at December 31, 2017 was $1.5 million.

 

As of December 31, 2016,2018, First Defiance’s total non-performing loans amounted to $14.3$19.0 million or 0.74%0.75% of total loans (net of undisbursed loan funds and deferred fees and costs), compared to $16.3$30.7 million or 0.90%1.31% of total loans, at December 31, 2015.2017. Non-performing loans are loans which are more than 90 days past due or on nonaccrual.non-accrual. The nonperformingnon-performing loan balance for 20162018 includes $11.3$16.3 million of loans that were originated by First Federal and also considered impaired, compared to $13.4$25.5 million for 2015.2017.

- 12 -

 

The following table sets forth the amounts and categories of First Defiance’s non-performing assets (excluding impaired loans not considered non-performing) and troubled debt restructurings at the dates indicated.

 

 December 31  December 31 
 2016  2015  2014  2013  2012  2018  2017  2016  2015  2014 
 (Dollars in Thousands)  (Dollars in Thousands) 
Nonperforming loans:                    
                    
Non-performing loans:                    
1-4 family residential real estate $2,928  $2,610  $3,332  $3,273  $3,602  $3,640  $3,037  $2,928  $2,610  $3,332 
Multi-family residential real estate  2,639   2,419   2,539   581   1,177   102   128   2,639   2,419   2,539 
Commercial real estate  6,953   7,429   12,635   15,253   21,913   10,255   18,091   6,953   7,429   12,635 
Commercial  1,007   3,078   4,993   8,327   5,661   4,500   8,841   1,007   3,078   4,993 
Home Equity and Improvement  730   689   619   413   217 
Home equity and improvement  393   590   730   689   619 
Consumer finance  91   36   12   -   -   126   28   91   36   12 
Total nonperforming loans  14,348   16,261   24,130   27,847   32,570 
Total non-performing loans  19,016   30,715   14,348   16,261   24,130 
                                        
Real estate owned  455   1,321   6,181   5,859   3,805   1,205   1,532   455   1,321   6,181 
Total repossessed assets  455   1,321   6,181   5,859   3,805   1,205   1,532   455   1,321   6,181 
                                        
Total nonperforming assets $14,803  $17,582  $30,311  $33,706  $36,375 
Total non-performing assets $20,221  $32,247  $14,803  $17,582  $30,311 
                                        
Restructured loans, accruing $10,544  $11,178  $24,686  $27,630  $28,203  $11,573  $13,770  $10,544  $11,178  $24,686 
                                        
Total nonperforming assets as a percentage of total assets  0.60%  0.77%  1.39%  1.58%  1.78%
Total nonperforming loans as a percentage of total loans*  0.74%  0.90%  1.47%  1.76%  2.14%
Total nonperforming assets as a percentage of total loans plus REO*  0.76%  0.97%  1.83%  2.12%  2.38%
Allowance for loan losses as a percent of total nonperforming assets  174.86%  144.36%  81.71%  74.02%  73.43%
Total non-performing assets as a percentage of total assets  0.64%  1.08%  0.60%  0.77%  1.39%
Total non-performing loans as a percentage of total loans*  0.75%  1.31%  0.74%  0.90%  1.47%
Total non-performing assets as a percentage of total loans plus OREO*  0.80%  1.37%  0.76%  0.97%  1.83%
Allowance for loan losses as a percent of total non-performing assets  140.11%  82.75%  174.86%  144.36%  81.71%

  

* Total loans are net of undisbursed loan funds and deferred fees and costs.

 

Allowance for Loan LossesFirst Defiance maintains an allowance for loan losses to absorb probable incurred credit losses in the loan portfolio. The allowance for loan loss is made up of two components. The first is a general reserve, which is used to record loan loss reserves for groups of homogenous loans in which the Company estimates the losses incurred in the portfolio based on quantitative and qualitative factors.

 

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The second component of the allowance for loan loss is the specific reserve in which the Company sets aside reserves based on the analysis of individual credits. In evaluating the adequacy of its allowance each quarter, management grades all loans in the commercial portfolio. See“Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations – Allowance for Loan LossesLosses” for further discussion on management’s evaluation of the allowance for loan losses.

- 13 -

 

Loans are charged against the allowance when such loans meet the Company’s established policy on loan charge-offs and the allowance itself is adjusted quarterly by recording a provision for loan losses. As such, actual losses and losses provided for should be approximately the same if the overall quality, composition and size of the portfolio remained static along with a static loan environment. To the extent that the portfolio grows at a rapid rate or overall quality or the loan environment deteriorates, the provision generally will exceed charge-offs. However, in certain circumstances, net charge-offs may exceed the provision for loan losses when management determines that loans previously provided for in the allowance for loan losses are uncollectible and should be charged offcharged-off or as overall credit or the loan environment improves. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowances may be necessary, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations.

 

At December 31, 2016,2018, First Defiance’s allowance for loan losses totaled $25.9$28.3 million compared to $25.4$26.7 million at December 31, 2015.2017. The following table sets forth the activity in First Defiance’s allowance for loan losses during the periods indicated.

 

 Years Ended December 31  Years Ended December 31 
 2016  2015  2014  2013  2012  2018  2017  2016  2015  2014 
 (Dollars in Thousands)  (Dollars in Thousands) 
                      
Allowance at beginning of year $25,382  $24,766  $24,950  $26,711  $33,254  $26,683  $25,884  $25,382  $24,766  $24,950 
Provision for credit losses  283   136   1,117   1,824   10,924   1,176   2,949   283   136   1,117 
Charge-offs:                                        
1-4 family residential real estate  (350)  (282)  (426)  (643)  (2,515)  (261)  (279)  (350)  (282)  (426)
Commercial real estate and multi-family  (92)  (468)  (1,018)  (2,475)  (11,319)  (1,387)  (429)  (92)  (468)  (1,018)
Commercial  (615)  (68)  (2,982)  (1,230)  (4,047)  (724)  (2,301)  (615)  (68)  (2,982)
Consumer finance  (94)  (53)  (41)  (94)  (133)  (233)  (139)  (94)  (53)  (41)
Home equity and improvement  (268)  (350)  (392)  (757)  (1,165)  (269)  (301)  (268)  (350)  (392)
Total charge-offs  (1,419)  (1,221)  (4,859)  (5,199)  (19,179)  (2,874)  (3,449)  (1,419)  (1,221)  (4,859)
Recoveries  1,638   1,701   3,558   1,614   1,712   3,346   1,299   1,638   1,701   3,558 
Net (charge-offs) recoveries  219   480   (1,301)  (3,585)  (17,467)  472   (2,150)  219   480   (1,301)
Ending allowance $25,884  $25,382  $24,766  $24,950  $26,711  $28,331   $ 2 6,683  $25,884  $25,382  $24,766 
                                        
Allowance for loan losses to total non-performing loans at end of year  180.40%  156.09%  102.64%  89.60%  82.01%  148.99%  86.87%  180.40%  156.09%  102.64%
Allowance for loan losses to total loans at end of year*  1.33%  1.41%  1.50%  1.58%  1.75%  1.12%  1.14%  1.33%  1.41%  1.50%
Net charge-offs (recoveries) for the year to average loans  -0.01%  -0.03%  0.08%  0.23%  1.18%  -0.02%  0.10%  -0.01%  -0.03%  0.08%

 

* Total loans are net of undisbursed loan funds and deferred fees and costs.

 

The provision for credit losses decreased significantly in 2016 and 20152018 from the previous yearsyear despite growth in the loan portfolio due to improveda decrease in net charge-offs and improving credit quality of the loan portfolio.quality. Management does not anticipate a net recovery position in 2017 and feels that the level of the allowance for loan losses at December 31, 20162018, is sufficient to cover the estimated losses incurred but not yet recognized in the loan portfolio.

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The following table sets forth information concerning the allocation of First Defiance’s allowance for loan losses by loan categories at the dates indicated. For information about the percent of total loans in each category to total loans, see “Lending“Lending Activities-Loan Portfolio Composition.”Composition” above.

 

 December 31  December 31 
 2016  2015  2014  2013  2012  2018  2017  2016  2015  2014 
    Percent of     Percent of     Percent of     Percent of     Percent of     Percent of     Percent of     Percent of     Percent of     Percent of 
    total loans     total loans     total loans     total loans     total loans     total loans     total loans     total loans     total loans     total loans 
 Amount  by category  Amount  by category  Amount  by category  Amount  by category  Amount  by category  Amount by category Amount by category Amount by category Amount by category Amount by category 
 (Dollars in Thousands)  (Dollars in Thousands) 
1-4 family residential $2,627   10.2% $3,212   11.0% $2,494   12.2% $2,847   12.2% $3,506   13.0% $2,881   12.1% $2,532   11.1% $2,627   10.2% $3,212   11.0% $2,494   12.2%
Multi-family residential real estate  2,228   9.7   2,151   9.0   2,453   9.3   2,508   9.2   2,197   7.9   3,101   10.4   2,702   10.1   2,228   9.7   2,151   9.0   2,453   9.3 
Commercial real estate  10,625   41.5   11,772   41.8   11,268   40.6   12,000   41.6   12,702   43.7   12,041   42.3   10,354   40.0   10,625   41.5   11,772   41.8   11,268   40.6 
Construction  450   9.0   517   8.7   221   6.7   134   5.3   75   2.5   682   10.0   647   10.8   450   9.0   1          517   8.7   221   6.7 
Commercial loans  7,361   23.0   5,192   22.4   6,509   23.7   5,678   24.1   6,325   24.9   7,281   19.1   7,965   21.3   7,361   23.0   5,192   22.4   6,509   23.7 
Home equity and improvement loans  2,386   5.8   2,270   6.2   1,704   6.6   1,635   6.6   1,759   7.0   2,026   4.8   2,255   5.5   2,386   5.8   2,270   6.2   1,704   6.6 
Consumer loans  207   0.8   171   0.9   117   0.9   148   1.0   147   1.0   319   1.3   228   1.2   207   0.8   171   0.9   117   0.9 
 $25,884   100.0% $25,382   100.0% $24,766   100.0% $24,950   100.0% $26,711   100.0% $28,331   100.0% $26,683   100.0% $25,884   100.0% $25,382   100.0% $24,766   100.0%

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Sources of Funds

 

GeneralDeposits are the primary source of First Defiance’s funds for lending and other investment purposes. In addition to deposits, First Defiance derives funds from loan principal repayments. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings from the FHLB may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes. During 2007, First Defiance issued $15.0 million of trust preferred securities through an unconsolidated affiliated trust. Proceeds from the offering were used for general corporate purposes including funding of dividends and stock buybacks as well as bolstering regulatory capital at the First Federal level. First Defiance also issued $20.0 million of similar trust preferred securities in 2005.

 

DepositsFirst Defiance’s deposits are attracted principally from within First Defiance’s primary market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts, and term certificate accounts. Deposit account terms vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit, and the interest rate.

 

To supplement its funding needs, First Defiance also has the ability to utilize the national market for Certificatescertificates of Deposit.deposit. First Defiance has used these deposits in the past and could in the future if necessary. The total balance ofFirst Defiance has no national market certificates of deposit was $0 atas of December 31, 2016 and 2015.2018 or 2017.

 

Average balances and average rates paid on deposits are as follows:

 

  Years Ended December 31 
  2016  2015  2014 
  Amount  Rate  Amount  Rate  Amount  Rate 
  (Dollars in Thousands) 
Non-interest-bearing demand deposits $441,731   -  $388,257   -  $350,677   - 
Interest bearing demand deposits  798,266   0.17%  742,856   0.16%  733,637   0.17%
Savings deposits  235,137   0.04   215,253   0.04   198,919   0.05 
Time deposits  430,487   1.12   441,510   0.92   466,951   0.85 
Totals $1,905,621   0.33% $1,787,876   0.30% $1,750,184   0.30%

- 15 -

  Years Ended December 31 
  2018  2017  2016 
  Amount  Rate  Amount  Rate  Amount  Rate 
  (Dollars in Thousands) 
Noninterest-bearing demand deposits $562,439   -  $528,926   -  $441,731   - 
Interest-bearing demand deposits  1,026,383   0.27%  955,248   0.18%  798,266   0.17%
Savings deposits  297,492   0.04   284,814   0.04   235,137   0.04 
Time deposits  621,239   1.78   530,414   1.33   430,487   1.12 
Totals $2,507,553   0.56% $2,299,402   0.38% $1,905,621   0.33%

 

The following table sets forth the maturities of First Defiance’s retail certificates of deposit having principal amounts $100,000$250,000 or greater at December 31, 20162018 (In Thousands):

 

Retail certificates of deposit maturing in quarter ending:    
March 31, 2017 $17,854 
June 30, 2017  16,394 
September 30, 2017  15,125 
December 31, 2017  8,322 
After December 31, 2017  109,862 
Total retail certificates of deposit with balances $100,000 or greater $167,557 

Retail certificates of deposit maturing in quarter ending:  
March 31, 2019 $24,347 
June 30, 2019  20,481 
September 30, 2019  8,791 
December 31, 2019  6,865 
After December 31, 2019  29,328 
Total retail certificates of deposit with
balances $250,000 or greater
 $89,812 

- 15 -

 

The following table details the deposit accrued interest payable as of December 31:

 

 2016  2015  2018  2017 
 (In Thousands)  (In Thousands) 
          
Interest bearing demand deposits and money market accounts $23  $18 
Interest-bearing demand deposits and
money market accounts
 $52  $29 
Certificates of deposit  19   25   314   68 
 $42  $43  $366  $97 

 

For additional information regarding First Defiance’s deposits see Note 11 to the Consolidated Financial Statements.

 

BorrowingsFirst Defiance may obtain advances from the FHLB of Cincinnati by pledging certain of its residential mortgage loans, commercial real estate loans, multi-family loans, home equity loans and investment securities provided certain standards related to creditworthiness have been met. Such advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities.

 

The following table sets forth certain information as to First Defiance’s FHLB advances and other borrowings at the dates indicated.

 

  Years Ended December 31 
  2016  2015  2014 
  (Dollars in Thousands) 
Long-term:            
FHLB advances $103,943  $59,902  $21,544 
Weighted average interest rate  1.42%  1.62%  2.38%
             
Short-term:            
Securities sold under  agreement to repurchase $31,816  $57,188  $54,759 
Weighted average interest rate  0.22%  0.27%  0.28%

- 16 -

  Years Ended December 31 
  2018  2017  2016 
  (Dollars in Thousands) 
Long-term:         
FHLB advances $60,189  $84,279  $103,943 
Weighted average interest rate  1.68%  1.55%  1.42%
             
Short-term:            
FHLB advances $25,000  $-  $- 
Weighted average interest rate  2.45%  -   - 
Securities sold under  agreement to repurchase $5,741  $26,019  $31,816 
Weighted average interest rate  0.31%  0.20%  0.22%

 

The following table sets forth the maximum month-end balance and average balance of First Defiance’s long-term FHLB advances and other borrowings during the periods indicated.

 

 Years Ended December 31  Years Ended December 31 
 2016  2015  2014  2018  2017  2016 
 (Dollars in Thousands)  (Dollars in Thousands) 
Long-term:                   
FHLB advances:                        
Maximum balance $103,943  $59,902  $22,520  $84,306  $105,214  $103,943 
Average balance  84,944   38,185   21,993   67,365   102,115   84,944 
Weighted average interest rate  1.42%  1.62%  2.38%  1.75%  1.44%  1.42%

 

The following table sets forth the maximum month-end balance and average balance of First Defiance’s short-term FHLB advances and other borrowings during the periods indicated.

 

 Years Ended December 31  Years Ended December 31 
 2016  2015  2014  2018  2017  2016 
 (Dollars in Thousands)  (Dollars in Thousands) 
Short-term:                   
FHLB advances:                        
Maximum balance $30,000  $-  $-  $40,000  $-  $30,000 
Average balance  861   41   -   6,082   44   861 
Weighted average interest rate  0.39%  0.18%  -   1.33%  0.80%  0.39%
Securities sold under agreement to repurchase:                        
Maximum balance $57,984  $60,272  $61,154  $5,741  $26,019  $57,984 
Average balance  52,821   54,632   54,541   8,911   23,337   52,821 
Weighted average interest rate  0.26%  0.28%  0.29%  0.26%  0.23%  0.26%

- 16 -

 

First Defiance borrows funds under a variety of programs at the FHLB. As of December 31, 2016,2018, there was $103.9$85.2 million outstanding under various long-term FHLB advance programs. First Defiance utilizes short-term advances from the FHLB to meet cash flow needs and for short-term investment purposes. At December 31, 20162018 and 2015,2017, no outstanding balances existed under First Defiance’s short-term Cash Management Advance Line of Credit or REPO line of credit.Credit. The total available under the Cash Management Advance Line is $15.0 million. Additionally,In addition, First Defiance has a $100.0 million REPO Advance line of credit available, under a REPOwhich $25.0 million was drawn at December 31, 2018. There were no borrowings against this line of credit.at December 31, 2017. Amounts are generally borrowed under these lines on an overnight basis. First Federal’sDefiance’s total borrowing capacity at the FHLB is limited by various collateral requirements. Eligible collateral includes mortgage loans, home equity loans, non-mortgage loans, cash, and investment securities. At December 31, 2016,2018, other than amounts available on the REPO and Cash Management line, First FederalDefiance had additional borrowing capacity with the FHLB of $448.9$447.4 million as a result of these collateral requirements.

 

As a member of the FHLB of Cincinnati, First Federal must maintain a minimum investment in the capital stock of that FHLB in an amount defined in the FHLB’s regulations. First Federal is permitted to own stock in excess of the minimum requirement and was in compliance with the minimum requirement with an investment in stock of the FHLB of Cincinnati of $13.8$14.2 million at December 31, 20162018, and 2015.$16.0 million at December 31, 2017. First Federal holdsheld stock of the FHLB of Indianapolis of $2,500 at December 31, 2018, and $5,000 at December 31, 2016 and $9,000 at December 31, 2015.2017.

 

Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLB. The standards take into account a member’s performance under the Community Reinvestment Act and its record of lending to first-time homebuyers.

 

For additional information regarding First Defiance’s FHLB advances and other debt see Notes 12 and 14 to the Consolidated Financial Statements.

 

- 17 -

Subordinated Debentures -In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (“Trust Affiliate II”) that issued $15.0 million of Guaranteed Capital Trust Securities (“Trust Preferred Securities”). In connection with the transaction, the Company issued $15.5 million of Junior Subordinated Deferrable Interest Debentures (“Subordinated Debentures”) to Trust Affiliate II. Trust Affiliate II was formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Subordinated Debentures held by Trust Affiliate II are the sole assets of the trust. Distributions on the Trust Preferred Securities issued by Trust Affiliate II are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.5%. The Coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate II was 2.46%4.29% and 2.01%3.09% as of December 31, 20162018 and 20152017, respectively.

 

The Trust Preferred Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures. The Company entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on June 15, 2037, but can be redeemed at the Company’s option at any time now.

- 17 -

 

In October 2005, the Company formed an affiliated trust, First Defiance Statutory Trust I (“Trust Affiliate I”) that issued $20.0 million of Trust Preferred Securities. In connection with the transaction, the Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Subordinated Debentures held by Trust Affiliate I are the sole assets of the trust. Distributions on the Trust Preferred Securities issued by Trust Affiliate I are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.38%, or 2.34%4.17% and 1.89%2.97% as of December 31, 20162018 and 20152017, respectively.

 

The Trust Preferred Securities issued by Trust Affiliate I are subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures. The Company entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on December 15, 2035, but can be redeemed by the Company at any time now.

 

Employees

Employees

 

First Defiance had 581696 employees at December 31, 2016.2018. None of these employees are represented by a collective bargaining agent, and First Defiance believes that it maintains good relationships with its personnel.

 

Competition

Competition

 

Competition in originating commercial real estate and commercial loans comes mainly from commercial banks with banking center offices in the Company’s market area. Competition for the origination of mortgage loans arises mainly from savings associations, commercial banks, and mortgage companies. The distinction among market participants is based on a combination of price, the quality of customer service and name recognition. The Company competes for loans by offering competitive interest rates and product types and by seeking to provide a higher level of personal service to borrowers than is furnished by competitors. First Federal has a significant market share of the lending markets in which it conducts operations, except for central Ohio.

 

Management believes that First Federal’s most direct competition for deposits comes from local financial institutions. The distinction among market participants is based on price and the quality of customer service and name recognition. First Federal’s cost of funds fluctuates with general market interest rates. During certain interest rate environments, additional significant competition for deposits may be expected from corporate and governmental debt securities, as well as from money market mutual funds. First Federal competes for conventional deposits by emphasizing quality of service, extensive product lines and competitive pricing.

 

- 18 -

Regulation

 

General –First Defiance is subject to regulation examination and oversight by the Federal Reserve Board (“Federal Reserve”). First Federal areis subject to regulation, examination and oversight by the Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve Board (“Federal Reserve”). Because the FDIC insures First Federal’s deposits, First Federal is also subject to examination and regulation by the FDIC. In addition, First Federal is subject to regulation and examination byregulations of the Consumer Financial Protection Bureau (the “CFPB”) which was established by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). and has broad powers to adopt and enforce consumer protection regulations. First Defiance and First Federal must file periodic reports with the Federal Reserve and the OCC and examinations are conducted periodically by the Federal Reserve, the OCC and the FDIC to determine whether First Defiance and First Federal are in compliance with various regulatory requirements and are operating in a safe and sound manner. First Federal is subject to various consumer protection and fair lending laws. These laws govern, among other things, truth-in-lending disclosure, equal credit opportunity, and, in the case of First Federal, fair credit reporting and community reinvestment. Failure to abide by federal laws and regulations governing community reinvestment could limit the ability of First Federal to open a new branch or engage in a merger transaction. Community reinvestment regulations evaluate how well and to what extent First Federal lends and invests in its designated service area, with particular emphasis on low-to-moderate income communities and borrowers in such areas.

 

First Defiance is also subject to various Ohio laws which restrict takeover bids, tender offers and control-share acquisitions involving public companies which have significant ties to Ohio.

 

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Economic Growth, Regulatory Relief and Consumer Protection Act

On May 25, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Regulatory Relief Act”) was signed into law. The Regulatory Relief Act was designed to provide regulatory relief for banking organizations, particularly for all but the very largest, those with assets in excess of $250 billion. Bank holding companies with assets of less than $100 billion are no longer subject to enhanced prudential standards, and those with assets between $100 billion and $250 billion will be relieved of those requirements in 18 months, unless the Federal Reserve Board takes action to maintain those standards. Certain regulatory requirements applied only to banks with assets in excess of $50 billion and so did not apply to First Federal even before the enactment of the Regulatory Relief Act.

The Regulatory Relief Act also provides that the banking regulators must adopt regulations implementing the provision that banking organizations with assets of less than $10 billion are permitted to satisfy capital standards and be considered “well capitalized” under the prompt corrective action framework if their leverage ratios of tangible assets to average consolidated assets is between 8% and 10%, unless the bank’s federal banking agency determines that the organization’s risk profile warrants a more stringent leverage ratio. The Office of the Comptroller of the Currency (“OCC”), the Federal Reserve Board and the FDIC have proposed for comment the leverage ratio framework for any banking organization with total consolidated assets of less than $10 billion, limited amounts of certain types of assets and off-balance sheet exposures, and a community bank leverage ratio greater than 9%. The community bank leverage ratio would be calculated as the ratio of tangible equity capital divided by average total consolidated assets. Tangible equity capital would be defined as total bank equity capital or total holding company equity capital, as applicable, prior to including minority interests, and excluding accumulated other comprehensive income, deferred tax assets arising from net operating loss and tax credit carry forwards, goodwill and other intangible assets (other than mortgage servicing assets). Average total assets would be calculated in a manner similar to the current tier 1 leverage ratio denominator in that amounts deducted from the community bank leverage ratio numerator would also be excluded from the community bank leverage ratio denominator.

The OCC, the Federal Reserve Board and the FDIC also adopted a rule providing banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of new current expected credit loss methodology accounting under U. S. generally accepted accounting principles (“GAAP”).

The Regulatory Relief Act also relieves bank holding companies and banks with assets of less than $100 billion in assets from certain record-keeping, reporting and disclosure requirements.

Holding Company RegulationFirst Defiance is a unitary thrift holding company and is subject to the Federal Reserve regulations, examination, supervision and reporting requirements. Federal law generally prohibits a thrift holding company from controlling any other savings association or thrift holding company, without prior approval of the Federal Reserve, or from acquiring or retaining more than 5% of the voting shares of a savings association or holding company thereof, which is not a subsidiary.

Regulatory Capital Requirements and Prompt Corrective ActionThe federal banking regulators have adopted risk-based capital guidelines for financial institutions and their holding companies, designed to absorb losses. The guidelines provide a systematic analytical framework, which makes regulatory capital requirements sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures expressly into account in evaluating capital adequacy and minimizes disincentives to holding liquid, low-risk assets. Capital levels as measured by these standards are also used to categorize financial institutions for purposes of certain prompt corrective action regulatory provisions.

 

In July 2013, the United Statesfederal banking regulators issued final new capital rules applicable to smaller banking organizations which also implement certain provisions of the Dodd-Frank Act. The new minimum capital requirements became effective on January 1, 2015, whereas a new capital conservation buffer and deductions from common equity capital phasephased in from January 1, 2016, through January 1, 2019, and most deductions from common equity tier 1 capital are being phased in from January 1, 2015, through January 1, 2019.

 

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The new rules include (a) a newminimum common equity tierTier 1 (“CET1”) capital ratio of at least 4.5%, (b) a minimum Tier 1 capital ratio of at least 6.0%, rather than the former 4.0%, (c) a minimum total capital ratio that remains atof 8.0%, and (d) a minimum leverage ratio of 4%.

 

Common equity for the common equity tier 1CET1 capital ratio includes common stock (plus related surplus) and retained earnings, plus limited amounts of minority interests in the form of common stock, less the majority of certain regulatory deductions.

 

Tier 1 capital includes common equity as defined for the common equity tier 1CET1 capital ratio, plus certain non-cumulative preferred stock and related surplus, cumulative preferred stock and related surplus and trust preferred securities that have been grandfathered (but which are not permitted going forward), and limited amounts of minority interests in the form of additional Tier 1 capital instruments, less certain deductions.

 

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Tier 2 capital, which can be included in the total capital ratio, includes certain capital instruments (such as subordinated debt) and limited amounts of the allowance for loan and lease losses (“ALLL”), subject to new eligibility criteria, less applicable deductions.

 

The deductions from common equity tier 1CET1 capital include goodwill and other intangibles, certain deferred tax assets, mortgage-servicing assets above certain levels, gains on sale in connection with a securitization, investments in a banking organization’s own capital instruments and investments in the capital of unconsolidated financial institutions (above certain levels). The deductions phase in through 2019.

 

Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of several risk weights is applied to different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

The new rules also place restrictions on the payment of capital distributions, including dividends, and certain discretionary bonus payments to executive officers if the company does not hold a capital conservation buffer of greater than 2.5% composed of common equity tier 1CET1 capital above its minimum risk-based capital requirements, or if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. The capital conservation buffer phaseswas fully phased in starting oneffective January 1, 2016,2019 at .625%2.5%.

 

The following table sets forth the amount and percentage level of regulatory capital of First Federal at December 31, 2016, and the amount by which it exceeded the minimum capital requirements in effect at that date. (Dollars in Thousands):

  Actual  Minimum Required for
Adequately Capitalized
  Minimum Required for Well
Capitalized
 
  Amount  Ratio  Amount  Ratio(1)  Amount  Ratio 
CET1 Capital (to Risk-Weighted Assets) (1)
Consolidated $234,809   10.45% $101,108   4.5%  N/A   N/A 
First Federal $242,928   10.81% $101,116   4.5% $146,057   6.5%
                         
Tier 1 Capital (2)                        
Consolidated $269,809   11.24% $95,975   4.0%  N/A   N/A 
First Federal $242,928   10.14% $95,791   4.0% $119,739   5.0%
                         
Tier 1 Capital (to Risk Weighted Assets) (1)
Consolidated $269,809   12.01% $134,811   6.0%  N/A   N/A 
First Federal $242,928   10.81% $134,822   6.0% $179,763   8.0%
                         
Total Capital (to Risk Weighted Assets) (1)
Consolidated $295,693   13.16% $179,748   8.0%  N/A   N/A 
First Federal $268,812   11.96% $179,763   8.0% $224,703   10.0%

(1)Excludes capital conservation buffer of 0.625% as of December 31, 2016.
(2)Core capital is computed as a percentage of adjusted total assets of $2.40 billion for consolidated and $2.39 billion for the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.25 billion for consolidated and the Bank.

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Prompt Corrective Action- The federal banking agencies have established a system of “prompt corrective action” to resolve certain problems of undercapitalized institutions.banks. This system is based on five capital level categories for insured depository institutions: "well“well capitalized," "adequately” “adequately capitalized," "undercapitalized," "significantly undercapitalized"” “undercapitalized,” “significantly undercapitalized” and "critically“critically undercapitalized." The federal banking agencies may (or in some cases must) take certain supervisory actions depending upon a bank's capital level. For example, the banking agencies must appoint a receiver or conservator for a bank within 90 days after it becomes "critically undercapitalized" unless the bank's primary regulator determines, with the concurrence of the FDIC, that other action would better achieve regulatory purposes. Banking operations otherwise may be significantly affected depending on a bank's capital category. For example, a bank that is not "well capitalized" generally is prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market, and the holding company of any undercapitalized depository institution must guarantee, in part, specific aspects of the bank's capital plan for the plan to be acceptable.

 

Effective January 1, 2015, in order to be "well-capitalized,"“well-capitalized,” a financial institution must have a common equity tier 1CET1 capital ratio of 6.5%, a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital of at least 8% and a leverage ratio of at least 5%, and the institution must not be subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. As of December 31, 2016,2018, First Federal met the ratio requirements in effect at that date to be deemed "well-capitalized." See Note 17 of the Notes to the Consolidated Financial Statements which is incorporated herein by reference.

 

Dividends

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The following table sets forth the amounts and percentage levels of regulatory capital of First Defiance and First Federal, the minimum amounts required for each of First Defiance and First Federal, and the amounts required for First Federal to be deemed well capitalized under the prompt corrective action system, all as of December 21, 2018. (Dollars in Thousands):

  Actual  Minimum Required for
Adequately Capitalized
  Minimum Required to be Well
Capitalized for Prompt
Corrective Action
 
  Amount  Ratio  Amount  Ratio(1)  Amount  Ratio 
CET1 Capital (to Risk-Weighted Assets) (2)            
Consolidated $303,860   11.00% $124,339   4.5%  N/A   N/A 
First Federal $322,520   11.68% $124,225   4.5% $179,436   6.5%
                         
Tier 1 Capital (2)                        
Consolidated $338,860   11.14% $121,716   4.0%  N/A   N/A 
First Federal $322,520   10.62% $121,461   4.0% $151,827   5.0%
                         
Tier 1 Capital (to Risk Weighted Assets) (2)             
Consolidated $338,860   12.26% $165,786   6.0%  N/A   N/A 
First Federal $322,520   11.68% $165,633   6.0% $220,844   8.0%
                         
Total Capital (to Risk Weighted Assets) (2)              
Consolidated $367,191   13.29% $221,048   8.0%  N/A   N/A 
First Federal $350,851   12,71% $220,844   8.0% $276,055   10.0%

(1)Excludes capital conservation buffer of 1.875% as of December 31, 2018.
(2)Core capital is computed as a percentage of adjusted total assets of $3.04 billion for consolidated and for the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.76 billion for consolidated and for the Bank.

In September 2017, the Federal Reserve, along with other bank regulatory agencies, proposed amendments to its capital requirements to simplify various aspects of the capital rules for community banks, including First Federal, in an attempt to reduce the regulatory burden for such smaller financial institutions. In November 2017, the federal banking agencies extended, for the community banks, the existing capital requirements for certain items that were scheduled to change effective January 1, 2018, in light of the simplification amendments being considered. As described above, the bank regulatory agencies have proposed revised capital requirements under the Regulatory Relief Act.

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DividendsDividends paid by First Federal to First Defiance are subject to various regulatory restrictions. First Federal paid $22.0 million in dividends to First Defiance in 20162018 and $29.0$13.0 million in 2015.2017. Generally, First Federal can initiate dividend payments equalmay not pay dividends to First Defiance in excess of its net profits (as defined by statute) for the last two fiscal years, plus any year to dateyear-to-date net profits.profits without the approval of the OCC. First Insurance paid $1.2$1.6 million in dividends to First Defiance in 20162018 and $900,000$1.8 million in dividends in 2015.2017. First Defiance Risk Management paid $1.0 million$950,000 in dividends to First Defiance in 20162018 and 2015.$1.0 million in dividends in 2017.

 

First Defiance’s ability to pay dividends to its shareholders is primarily dependent on its receipt of dividends from the Subsidiaries. The Federal Reserve expects First Defiance to serve as a source of strength for First Federal and may require First Defiance to retain capital for further investment in First Federal, rather than pay dividends to First Defiance shareholders. Payment of dividends by First Defiance or First Federal may be restricted at any time at the discretion of its applicable regulatory authorities if they deem such dividends to constitute an unsafe or unsound banking practice. These provisions could have the effect of limiting First Defiance's ability to pay dividends on its common shares.

 

Transactions with Insiders and Affiliates -Loans to executive officers, directors and principal shareholders and their related interests must conform to the lending limits. Most loans to directors, executive officers and principal shareholders must be approved in advance by a majority of the “disinterested” members of board of directors of the association with any “interested” director not participating. All loans to directors, executive officers and principal shareholders must be made on terms substantially the same as offered in comparable transactions with the general public or as offered to all employees in a company-wide benefit program. Loans to executive officers are subject to additional restrictions. In addition, all related party transactions must be approved by the Company’s audit committee pursuant to NASDAQ Rule 5630, including loans made by financial institutions in the ordinary course of business. All transactions between savings associations and their affiliates must comply with Sections 23A and 23B of the Federal Reserve Act (“FRA”) and the Federal Reserve’s Regulation W. An affiliate of a savings association is any company or entity that controls, is controlled by, or is under common control with the savings association. First Defiance, First Defiance Risk Management and First Insurance are affiliates of First Federal.

 

Holding Company Regulation -First Defiance is a unitary thrift holding company and is subject to the Federal Reserve regulations, examination, supervision and reporting requirements. Federal law generally prohibits a thrift holding company from controlling any other savings association or thrift holding company, without prior approval of the Federal Reserve, or from acquiring or retaining more than 5% of the voting shares of a savings association or holding company thereof, which is not a subsidiary.

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Deposit Insurance -Substantially all of the deposits of First Federal are insured up to applicable limits byThe FDIC maintains the Deposit Insurance Fund (“DIF’), which insures the deposit accounts of First Federal to the maximum amount provided by law. The general insurance limit is $250,000 per separately insured depositor. This insurance is backed by the full faith and credit of the United States government.

The FDIC and First Federal is assessedassesses deposit insurance premiums to maintain the Deposit Insurance Fund. Insurance premiums foron each insured institution are determinedquarterly based uponon risk characteristics of the institution’s capital level and supervisory rating providedinstitution. The FDIC may also impose a special assessment in an emergency situation.

Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (“DRR”), which is the ratio of the DIF to insured deposits of the total industry. In March 2016, the FDIC adopted final rules designed to meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the institution’s primary federal regulator and other information deemed byDodd-Frank Act. The Dodd-Frank Act requires the FDIC to be relevantoffset the effect on institutions with assets of less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. The FDIC’s rules reduced assessment rates on all banks but imposed a surcharge on banks with assets of $10 billion or more until the DRR reaches 1.35% and provide assessment credits to banks with assets of less than $10 billion for the portion of their assessments that contribute to the risk posed to the Deposit Insurance Fund by the institution. The assessment rate is then applied to the amountincrease of the institution’s depositsDRR to determine the institution’s insurance premium.

1.35%. The deposit insurance assessment base is average assets less average tangible equity.DRR reached 1.36% at September 30, 2018. The FDIC set a target size for the Deposit Insurance Fund at 2% of insured deposits and a lower assessment rate schedule when the fund reaches 1.15% and, in lieu of dividends, the FDIC rule provides for a lower rate schedulecredits will be applied when the reserve ratio reaches 2% and 2.5%is at least 1.38%. On June 30, 2016,The rules also changed the Deposit Insurance Fund surpassed its target of 1.15%, decreasing the assessment base based on the final rules approved by the FDIC Board of Directors on February 7, 2011, and April 26, 2016. The changemethod to the assessment base anddetermine risk-based assessment rates as well as the Deposit Insurance Fund restoration time frame, has lowered First Defiance’s deposit insurance assessment.

In addition, the FDIC has proposed changing the deposit insurance premium assessment method for established banks with less than $10 billion in assets to better ensure that have beenbanks taking on greater risks pay more for deposit insurance than less risky banks.

In addition, all institutions with deposits insured by the FDIC for at least five years.are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize a predecessor to the DIF. These assessments will continue until the Financing Corporation bonds mature in September 2019. The proposed changes would reviseFinancing Corporation has projected that the financial ratios method so that it wouldlast assessment will be basedcollected on a statistical model estimating the probability of failure of a bank over three years; update the financial measures used in the financial ratios method consistent with the statistical model; and eliminate risk categories for established small banks and using the financial ratios method to determine assessment rates for all such banks (subject to minimum or maximum initial assessment rates based upon a bank’s composite examination rating).March 29, 2019 FDIC invoice.

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As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, federally-insured institutions. It also may prohibit any federally-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the Deposit Insurance Fund.DIF. The FDIC also has the authority to take enforcement actions against insured institutions. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged or is engaging in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or written agreement entered into with the FDIC.

Consumer Protection Laws and RegulationsBanks are subject to regular examination to ensure compliance with federal statutes and regulations applicable to their business, including consumer protection statutes and implementing regulations. Potential penalties under these laws include, but are not limited to, fines. The managementDodd-Frank Act established the CFPB, which has extensive regulatory and enforcement powers over consumer financial products and services. The CFPB has adopted numerous rules with respect to consumer protection laws, amending some existing regulations and adopting new ones, and has commenced enforcement actions. The following are just some of the consumer protection laws applicable to First Federal does not knowFederal:

•      Community Reinvestment Act of 1977 (“CRA”): imposes a continuing and affirmative obligation to fulfill the credit needs of its entire community, including low- and moderate-income neighborhoods.

•      Equal Credit Opportunity Act: prohibits discrimination in any credit transaction on the basis of any of various criteria.

•      Truth in Lending Act: requires that credit terms are disclosed in a manner that permits a consumer to understand and compare credit terms more readily and knowledgeably.

•      Fair Housing Act: makes it unlawful for a lender to discriminate in its housing-related lending activities against any person on the basis of any of certain criteria.

•      Home Mortgage Disclosure Act: requires financial institutions to collect data that enables regulatory agencies to determine whether the financial institutions are serving the housing credit needs of the communities in which they are located.

•      Real Estate Settlement Procedures Act: requires that lenders provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibits abusive practices that increase borrowers’ costs.

•      Privacy provisions of the Gramm-Leach-Bliley Act: requires financial institutions to establish policies and procedures to restrict the sharing of non-public customer data with non-affiliated parties and to protect customer information from unauthorized access.

The banking regulators also use their authority under the Federal Trade Commission Act to take supervisory or enforcement action with respect to unfair or deceptive acts or practices by banks that may not necessarily fall within the scope of specific banking or consumer finance law.

In October 2017, the CFPB issued a final rule (the “Payday Rule”) with respect to certain consumer loans to be effective on January 16, 2018, although compliance with most sections is required starting on August 19, 2019. The first major part of the rule makes it an unfair and abusive practice condition or violationfor a lender to make short-term and longer-term loans with balloon payments (with certain exceptions) without reasonably determining that might leadthe borrower has the ability to terminationrepay the loan. The second major part of deposit insurance.the rule applies to the same types of loans as well as certain other longer-term loans that are repaid directly from the borrower's account. The rule states that it is an unfair and abusive practice for the lender to withdraw payment from the borrower's account after two consecutive payment attempts have failed, unless the lender obtains the consumer's new and specific authorization to make further withdrawals from the account. The rule also requires lenders to provide certain notices to the borrower before attempting to withdraw payment on a covered loan from the borrower’s account.

 

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On February 6, 2019, the CFPB issued two proposals with respect to the Payday Rule. First, the CFPB proposed to delay the compliance date for the mandatory underwriting provisions of the Payday Rule to November 19, 2020. It has requested comments on the proposed delay to be made within 30 days. Second, the CFPB proposed to rescind provisions of the Payday Rule that (1) provide that it is an unfair and abusive practice for a lender to make a covered short-term or longer-term balloon-payment loan without reasonably determining that the consumer has the ability to repay the loan according to its terms; (2) prescribe mandatory underwriting requirements for making the ability-to-repay determination; (3) provide exemptions of certain loans from the mandatory underwriting requirements; and (4) provide related definitions, reporting and recordkeeping requirements. The CFPB has requested comments to be made within 90 days on this proposal. These proposals do not change the provisions of the Payday Rule that address lender payment practices with respect to covered loans. The CFPB also stated that it will be considering other changes to the Payday Rule in response to requests received for exemptions of certain types of lenders or loan products and may commence separate additional rulemaking initiatives.

CRA - Under the CRA, every FDIC-insured institution is obligated, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA requires the appropriate federal banking regulator, in connection with the examination of an insured institution, to assess the institution’s record of meeting the credit needs of its community and to consider this record in its evaluation of certain applications to banking regulators, such as an application for approval of a merger or the establishment of a branch. An unsatisfactory rating may be used as the basis for the denial of an application to acquire another financial institution or open a new branch. As of its last examination, First Federal received a CRA rating of “satisfactory.”

In June 2010, the Federal Reserve, the OCC and the FDIC issued joint interagency guidance on incentive compensation policies (the Joint Guidance) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. This principles-based guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should: (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks; (ii) be compatible with effective internal controls and risk management; and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. The Joint Guidance made incentive compensation part of the regulatory agencies’ examination process, with the findings of the supervisory initiatives included in reports of examination and enforcement actions possible.

In May 2016, the federal bank regulatory agencies approved a joint notice of proposed rules (the “Proposed Joint Rules”) designed to prohibit incentive-based compensation arrangements that encourage inappropriate risks at financial institutions. The Proposed Joint Rules would apply to covered financial institutions with total assets of $1 billion or more. For all covered institutions, including Level 3 institutions like First Defiance, the proposed rule would:

•      prohibit incentive-based compensation arrangements that are “excessive” or “could lead to material financial loss;”

•      require incentive based compensation that is consistent with a balance of risk and reward, effective management and control of risk, and effective governance; and

•      require board oversight, recordkeeping and disclosure to the appropriate regulatory agency.

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Further, as stock exchanges impose additional listing requirements under the Dodd-Frank Act, public companies will be required to implement “clawback” procedures for incentive compensation payments and to disclose the details of the procedures, which allow recovery of incentive compensation that was paid on the basis of erroneous financial information necessitating a restatement due to material noncompliance with financial reporting requirements. This clawback policy is intended to apply to compensation paid within a three-year look-back window of the restatement and would cover all executives who received incentive awards.

Patriot ActItem 1A. Risk FactorsIn response to the terrorist events of September 11, 2001, the Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the Patriot Act) was signed into law in October 2001. The Patriot Act gives the United States government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Title III of the Patriot Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions. Among other requirements, Title III and related regulations require regulated financial institutions to establish a program specifying procedures for obtaining identifying information from customers seeking to open new accounts and establish enhanced due diligence policies, procedures and controls designed to detect and report suspicious activity. First Federal has established policies and procedures that it considers to be in compliance with the requirements of the Patriot Act.

Volcker Rule – The Volcker Rule under the Dodd-Frank Act prohibits banks and their affiliates from engaging in proprietary trading and investing in and sponsoring hedge funds and private equity funds. The Volcker Rule, which became effective in July 2015, does not impact the operations of First Defiance or its subsidiaries, as the Company does not engage in the businesses prohibited by the Volcker Rule and banks under $10.0 billion in assets are exempted from the Volcker Rule provisions.

Item1A. Risk Factors

 

The risks listed below present risks that could have a material impact on the Company’s financial condition, results of operations, or business. The risks and uncertainties described below are the not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations.

 

Economic, political and financial market conditions may adversely affect First Defiance’s operations and financial condition.

 

First Defiance’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services First Defiance offers, is highly dependent upon the business environment in the markets where the Company operates, mainly in the State of Ohio, Northeast Indiana and in the Great Lake Region.Southeast Michigan. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability of or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters; or a combination of these or other factors. Conditions such as inflation, recession, unemployment, changes in interest rates, fiscal and monetary policy and other factors beyond First Defiance’s control may adversely affect its deposit levels and cost/composition, demand for loans, the ability of its borrowers to repay their loans and the value of the collateral securing the loans it makes. Economic turmoil in Europe and Asia and changes in oil production in the Middle East affect the economy and stock prices in the United States, which can affect First Defiance’s earnings and capital and the ability of its customers to repay loans. Because First Defiance has a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral and First Defiance’s ability to sell the collateral upon foreclosure.

 

The election of a new United States President in 2016 has resulted in substantial changes in economic and political conditions for the United States and the remainder of the world. Economic turmoil in Europe and Asia and changes in oil production in the Middle East affect the economy and stock prices in the United States. The timing and circumstances of the United Kingdom leaving the European Union (Brexit) and their effects on the United States are unknown. While these changes do not have a direct, immediate impact on First Defiance’s financial performance, we cannot predict how the change in the political climate will affect the economy and First Defiance’s performance in the future.

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First Defiance’s loan portfolio includes a concentration of commercial real estate loans and commercial loans, which involve risks specific to real estate value and the successful operations of these businesses.

 

At December 31, 2016,2018, First Federal’s portfolio of commercial real estate loans totaled $1.0$1.4 billion, or approximately 51.1%52.2% of total loans. First Federal’s commercial real estate loans typically have higher principal amounts than residential real estate loans, and many of our commercial real estate borrowers have more than one loan outstanding. As a result, an adverse development on one loan can expose First Defiance to greater risk of loss on other loans. Additionally, repayment of the loans is generally dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic conditions and events outside of the control of the borrower or lender could negatively impact the future cash flowflows and market values of the affected properties.

 

At December 31, 2016,2018, First Federal’s portfolio of commercial loans totaled $469.1$509.6 million, or approximately 23.1%19.1% of total loans. Commercial loans generally expose First Defiance to a greater risk of nonpayment and loss than commercial real estate or residential real estate loans since repayment of such loans often depends on the successful operations and income stream of the borrowers. First Federal’s commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower such as accounts receivable, inventory, machinery or real estate. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists.

 

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First Defiance targets its business lending towards smallsmall- and medium-sized businesses, many of which have fewer financial resources than larger companies and may be more susceptible to economic downturns. If general economic conditions negatively impact these businesses, First Defiance’s results of operations and financial condition may be adversely affected.

 

Increases to the allowance forIf First Defiance's actual loan losses may cause First Defiance’s earnings to decrease.

First Federal makes a number of assumptions and judgments about the collectability ofexceed its loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. In determining the amount of the allowance for loan losses, First Federal relies onDefiance's net income will decrease.

In accordance with GAAP, First Defiance must maintain an allowance for loan quality reviews, past losslosses to provide for loan defaults and non-performance, which when combined, are referred to as the allowance for loan losses. First Defiance's allowance for loan losses is based upon a number of relevant factors, including, but not limited to, trends in the level of nonperforming assets and classified loans, current economic conditions in the primary lending area, prior experience, possible losses arising from specific problem loans, and anmanagement's evaluation of economic conditions, amongthe risks in the current portfolio. However, there are many factors that can result in actual loan losses exceeding the allowance.

For instance, in deciding whether to extend credit or enter into other factors. If its assumptions provetransactions with customers and counterparties, First Defiance may rely on information provided to us by customers and counterparties, including financial statements and other financial information. First Defiance may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Such information may not turn out to be incorrect,accurate. Further, First Federal’sDefiance's loan customers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. As a result, First Defiance may experience significant loan losses, which could have a material adverse effect on its operating results.

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The amount of future losses also is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond management's control, and these losses may exceed current estimates. Further, federal regulatory agencies, as an integral part of their examination process, review First Defiance's loans and allowance for loan losses and may require that First Defiance increase its allowance. Moreover, the Financial Accounting Standards Board (“FASB”) has changed its requirements for establishing the allowance, which will be effective for First Defiance in the first quarter of 2020. That accounting change exposes First Defiance to increased risk of failure to establish a sufficient allowance and the possibility that First Defiance will need to increase its allowance substantially through an increase to the provision for loan losses, which will adversely affect First Defiance's net income.

As a result of any of the above factors, First Defiance's allowance for loan losses may not be sufficientadequate to cover actual credit losses, resulting in additions to the allowance. In addition, bank regulators periodically reviewand future provisions for credit losses could have a material adverse effect on First Federal’s allowance and may requireDefiance's operating results. There is no assurance that First Federal toDefiance will not further increase its allowance. Material additions to the allowance and anyfor loan losses that exceedlosses. Either of these occurrences could have a material adverse effect on First Federal’s reserves would materially adversely affect First Defiance’sDefiance's financial condition and results of operations and financial condition.operations.

 

Changes in interest rates can adversely affect First Defiance’s profitability.

 

First Defiance’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities, and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond First Defiance’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Open Market Committee. Changes in monetary policy, including changes in interest rates, could influence not only the interest First Defiance receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) First Defiance’s ability to originate loans and obtain deposits, (ii) the fair value of First Defiance’s financial assets and liabilities, and (iii) the average duration of certain assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, First Defiance’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. While we generally invest in securities with limited credit risk, certain investment securities we hold possess higher credit risk since they represent beneficial interests in structured investments collateralized by residential mortgages. All investment securities are subject to changes in market value due to changing interest rates and implied credit spreads. Any substantial, unexpected, or prolonged change in market interest rates could have a material adverse effect on First Defiance’s results of operations and financial condition.

 

First Federal originates a significant amount of residential mortgage loans that it sells in the secondary market. The origination of residential mortgage loans is highly dependent on the local real estate market and the current interest rates. Increasing interest rates tend to reduce the origination of loans for sale and consequently fee income, which First Defiance reports as mortgage banking income. Conversely, decreasing interest rates have the effect of causing clients to refinance mortgage loans faster than anticipated. This causes the value of mortgage servicing rights on the loans sold to be lower than originally anticipated. If this happens, First Defiance may be required to write down the value of its mortgage servicing rights faster than anticipated, which will increase expense and lower earnings. Accelerated repayments on loans and mortgage backed securities could result in the reinvestment of funds at lower rates than the loans or securities were paying.

 

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Laws, regulations and regulationsperiodic regulatory reviews may affect First Defiance’s results of operations.

 

The earnings of financial institutions are affected by the regulations and policies of various regulatory authorities, including the Federal Reserve, the OCC, the FDIC and the CFPB. The Federal Reserve has extensive supervisory authority over the Company, affecting a comprehensive range of matters relating to ownership and control of First Defiance’s shares, First Defiance’s acquisition of other companies and businesses, permissible activities for the Company to engage in, maintenance of adequate capital levels and other aspects of operations. These supervisory and regulatory powers are intended primarily for the protection of First Defiance’s depositors and borrowers and the deposit insurance fund,DIF, rather than First Defiance’s shareholders.

 

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Comprehensive revisions

As discussed above, in October 2017, the CFPB issued the Payday Rule with respect to certain consumer loans to be effective on January 16, 2018, although compliance with most sections is required starting on August 19, 2019. Then, on February 6, 2019, the CFPB issued two proposals with respect to the regulatory capital framework were finalizedPayday Rule regarding the underwriting provisions. These proposals do not change the provisions of the Payday Rule that address lender payment practices with respect to covered loans. The CFPB also stated that it will be considering other changes to the Payday Rule in response to requests received for exemptions of certain types of lenders or loan products and may commence separate additional rulemaking initiatives. First Defiance is currently assessing the expected effect of this new rule on First Defiance's lending businesses and on First Defiance’s financial condition and results of operations. The costs of complying with this regulation or a determination to discontinue certain types of consumer lending in light of the expense of compliance could have an adverse effect on the financial conditions and results of operations of the Company.

Changes in tax laws could adversely affect First Defiance's financial condition and results of operations.

First Defiance is subject to extensive federal, state and local taxes, including income, excise, sales/use, payroll, franchise, withholding and ad valorem taxes. Changes to the tax laws could have a material adverse effect on First Defiance's results of operations. In addition, First Defiance's customers are subject to a wide variety of federal, state and local taxes. Changes in taxes paid by customers, including changes in the Federal Reserve, the OCC, and the FDIC in 2013. The revised regulations change what qualifies as regulatory capital, raises minimum requirements, and introduces the conceptdeductibility of additional capital buffers. The need to maintain more and higher quality capital as well as greater liquidity going forward could limit our business activities, including lending, and ourmortgage loan related expenses, may adversely affect their ability to expand, either organicallypurchase homes or through acquisitions.consumer products, which could adversely affect their demand for First Defiance's loans and deposit products. In addition, such negative effects on First Defiance's customers could result in defaults on the loans already made and decrease the value of mortgage-backed securities in which First Defiance has invested.

On December 22, 2017, H.R.1, formally known as the “Tax Cuts and Jobs Act,” was enacted into law. This new liquidity standards could require ustax legislation, among other changes, limits the amount of state, federal and local taxes that taxpayers are permitted to increase our holdingsdeduct on their individual tax returns and eliminates other deductions in their entirety. Such limits and eliminations may result in customer defaults on loans already made and decrease the value of highly liquid short-term investments, thereby reducing our ability to investmortgage-backed securities in longer-term assets even if more desirable from a balance sheet management perspective.which First Defiance has invested.

 

The laws and regulations applicable to the banking industry could change at any time. The potential exists for new laws and regulations, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations. Increased regulation could increase First Defiance’s cost of compliance and reduce its income to the extent that they limit the manner in which First Defiance may conduct business, including its ability to offer new products, charge fees for specific products and services, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads.

 

First Defiance’s ability to meet cash flow needs on a timely basis at a reasonable cost may adversely affect net income.

 

First Defiance’s principal sources of liquidity are local deposits and wholesale funding sources such as FHLB advances, Federal Funds purchased, securities sold under repurchase agreements, and brokered or other out-of-market certificate of deposit purchases. Also, First Defiance maintains a portfolio of securities that can be used as a secondary source of liquidity. First Defiance’s access to funding sources in amounts adequate to finance or capitalize its activities or on terms that are acceptable could be impaired by factors that affect First Defiance directly or the financial services industry or economy in general, such as further disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry.

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Other possible sources of liquidity include the sale or securitization of loans, the issuance of additional collateralized borrowings beyond those currently utilized with the FHLB, the issuance of debt securities and the issuance of preferred or common securities in public or private transactions, or borrowings from a commercial bank. First Defiance does not currently have any borrowings from a commercial bank, but it has used them in the past.

 

Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to First Defiance’s shareholders, or fulfill obligations such as repaying First Defiance’s borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.

 

Competition affects First Defiance’s earnings.

 

First Defiance’s continued profitability depends on its ability to continue to effectively compete to originate loans and attract and retain deposits. Competition for both loans and deposits is intense in the financial services industry. The Company competes in its market area by offering superior service and competitive rates and products. The type of institutions First Defiance competes with include large regional commercial banks, smaller community banks, savings institutions, mortgage banking firms, credit unions, finance companies, brokerage firms, insurance agencies and mutual funds. As a result of their size and ability to achieve economies of scale, certain of First Defiance’s competitors can offer a broader range of products and services than the Company can offer. In addition, the OCC has recently announced that it will start accepting applications for bank charters from nondepository financial technology companies engaged in banking activities, which will add to the number of parties with whom the Company competes. Further, technological advances allow consumers to pay bills and transfer funds electronically without banks. Consumers can also shop for higher deposit interest rates at banks across the country, which may offer higher rates because they have few or no physical branches. To stay competitive in its market area, First Defiance may need to adjust the interest rates on its products to match rates of its competition, which could have a negative impact on net interest margin.

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The increasing complexity of First Defiance’s operations presents varied risks that could affect its earnings and financial condition.

 

First Defiance processes a large volume of transactions on a daily basis and is exposed to numerous types of risks related to internal processes, people and systems. These risks include, but are not limited to, the risk of fraud by persons inside or outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, breaches of data security and our internal control system and compliance with a complex array of consumer and safety and soundness regulations. First Defiance could also experience additional loss as a result of potential legal actions that could arise as a result of operational deficiencies or as a result of noncompliance with applicable laws and regulations.

 

First Defiance has established and maintains a system of internal controls that provides management with information on a timely basis and allows for the monitoring of compliance with operational standards. These systems have been designed to manage operational risks at an appropriate, cost effective level. Procedures exist that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. Losses from operational risks may still occur, however, including losses from the effects of operational errors.

 

Unauthorized disclosure of sensitive or confidential client or customer information or confidential trade secrets, whether through a breach of the Company’s computer systems or otherwise, could severely harm its business.

 

Potential misuse of funds or information by First Defiance’s employees or by third parties could result in damage to First Defiance’s customers for which First Defiance could be held liable, subject First Defiance to regulatory sanctions and otherwise adversely affect First Defiance’s financial condition and results of operations.

 

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First Defiance’s employees handle a significant amount of funds, as well as financial and personal information. First Defiance also depends upon third-party vendors who have access to funds and personal information about customers. Cybersecurity breaches of other companies, such as the breach of the systems of a credit bureau, may result in criminals using personal information obtained from such other source to impersonate a customer of First Defiance and obtain funds from customer accounts. Further, First Defiance may be affected by data breaches at retailers and other third parties who participate in data interchanges with First Defiance’s customers that involve the theft of customer credit and debit card data, which may include the theft of debit card personal identification numbers (“PIN”) and commercial card information used to make purchases at such retailers and other third parties. Such data breaches could result in First Defiance incurring significant expenses to reissue debit cards and cover losses, which could result in a material adverse effect on First Defiance’s results of operations.

Although First Defiance has implemented systems to minimize the risk of fraudulent taking or misuse of funds or information, there can be no assurance that such systems will be adequate or that a taking or misuse of funds or information by employees, by third parties who have authorized access to funds or information, or by third parties who are able to access funds or information without authorization will never occur. First Defiance could be held liable for such an event and could also be subject to regulatory sanctions. First Defiance could also incur the expense of developing additional controls and investing in additional equipment or contracts to prevent future such occurrences. Although First Defiance has insurance to cover such potential losses, First Defiance cannot provide assurance that such insurance will be adequate to meet any liability.liability, and insurance premiums may rise substantially if First Defiance suffers such an event. In addition, any loss of trust or confidence placed in First Defiance by our clientscustomers could result in a loss of business, which could adversely affect our financial condition and results of operations.operations, or result in a loss of investor confidence, hurting First Defiance’s stock price and ability to acquire capital in the future. First Defiance could also lose revenue by the wrongful appropriation of confidential information about its business operations by competitors who use the information to compete with First Defiance.

 

First Defiance could suffer a material adverse impact from interruptions in the effective operation of, or security breaches affecting, First Defiance’s computer systems.

 

First Defiance relies heavily on its own information systems and those of vendors to conduct our business and to process, record, and monitor transactions. Risks to the system could result from a variety of factors, including the potential for bad acts on the part of hackers, criminals, employees and others. As one example, some banks have experienced denial of service attacks in which individuals or organizations flood the bank’s website with extraordinarily high volumes of traffic, with the goal and effect of disrupting the ability of the bank to process transactions. Other businesses have been victims of a ransomware attack in which a business becomes unable to access its own information and is presented with a demand to pay a ransom in order to once again have access to its information. First Defiance is also at risk for the impact of natural disasters, terrorism and international hostilities on its systems or for the effects of outages or other failures involving power or communications systems operated by others. These risks also arise from the same types of threats to businesses with which First Defiance deals.

 

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Potential adverse consequences of attacks on First Defiance’s computer systems or other threats include damage to First Defiance’s reputation, loss of customer business, costs of incentives to customers or business partners in order to maintain their relationships, loss of investor confidence and a reduction in First Defiance’s stock price, litigation, and increased regulatory scrutiny and potential enforcement actions, repairs of system damage, increased investments in cybersecurity (such as obtaining additional technology, making organizational changes, deploying additional personnel, training personnel and engaging consultants), and increased insurance premiums, all of which might alsocould result in financial loss and require additional effortsmaterial adverse effects on First Defiance’s results of operations and expense to attempt to prevent such adverse consequences in the future.financial condition.

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If First Defiance forecloses on collateral property resulting in First Defiance’s ownership of the underlying real estate, First Defiance may be subject to the increased costs associated with the ownership of real property, resulting in reduced income.

 

A significant portion of First Defiance’s loan portfolio is secured by real property. During the ordinary course of business, First Defiance may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, First Defiance may be liable for remediation costs, as well as for personal injury and property damage.

 

In addition, when First Defiance forecloses on real property, the amount First Defiance realizes after a default is dependent upon factors outside of First Defiance’s control, including, but not limited to, economic conditions, neighborhood real estate values, interest rates, real estate taxes, operating expenses of the mortgaged properties, zoning laws, governmental rules, regulations and fiscal policies, and acts of God. Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating real property may exceed the rental income earned from such property, and First Defiance may have to sell the property at a loss. The foregoing expenditures could adversely affect First Defiance’s financial condition and results of operations.

 

First Defiance’s business strategy includesfocuses on planned growth. First Defiance’sgrowth, including strategic acquisitions, and its financial condition and results of operations could be negatively affected if First Defiance fails to grow or fails to manage its growth effectively.

 

First Defiance’s ability to grow successfully will depend on a variety of factors, including the continued availability of desirable business opportunities, its ability to integrate mergers and other acquisitions and manage growth and First Defiance’s ability to raise capital. There can be no assurance that growth opportunities will be available.

 

First Defiance may acquire other financial institutions or parts of institutions in the future, open new branches, and consider new lines of business and new products or services. Expansions of its business would involve a number of expenses and risks, including:

 

·the time and costs associated with identifying and evaluating potential acquisitions or expansions into new markets;
·the potential inaccuracy of estimates and judgments used to evaluate the business and risks with respect to target institutions;
·the time and costs of hiring local management and opening new offices;
·the delay between commencing making acquisitions or engaging in new activities and the generation of profits from the expansion;
·First Defiance’s ability to finance an expansion and the possible dilution to existing shareholders;
·the diversion of management’s attention to the expansion;
·management’s lack of familiarity with new market areas;
·the integration of new products and services and new personnel into First Defiance’s existing business;

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·the incurrence and possible impairment of goodwill associated with an acquisition and effects on First Defiance’s results of operations; and
·the risk of loss of key employees and customers.

 

If First Defiance’s growth involves the acquisition of companies through merger,mergers or other acquisitions, the success of the mergersuch acquisitions will depend on, among other things, First Defiance’s ability to combine the businesses in a manner that permits growth opportunities and cost efficiencies, and does not cause inconsistencies in standards, controls, procedures and policies that adversely affect the ability of First Defiance to maintain relationships with customers and employees or to achieve the anticipated benefits of the merger.acquisitions.

 

Failure to manage First Defiance’s growth effectively could have a material adverse effect on its business, future prospects, financial condition or results of operations and could adversely affect First Defiance’s ability to successfully implement its business strategy.

 

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First Defiance’s ability to pay dividends is subject to regulatory limitations which, to the extent First Defiance requires such dividends in the future, may affect its ability to pay dividends or repurchase its stock.

 

As a savings and loanunitary thrift holding company, First Defiance is a separate legal entity from First Federal and does not have significant operations of its own. Dividends from First Federal provide a significant source of capital for First Defiance. The availability of dividends from First Federal is limited by various statutes and regulations. The federal banking regulators require that insured financial institutions and their holding companies should generally only pay dividends out of current operating earnings. It is possible, depending upon the financial condition of First Federal and other factors, that the OCC, as First Federal’s primary regulator, could assert that the payment of dividends or other payments by First Federal are an unsafe or unsound practice. In the event First Federal is unable to pay dividends to First Defiance, First Defiance may not be able to pay its obligations as they become due, repurchase its stock, or pay dividends on its common stock. Consequently, the potential inability to receive dividends from First DefianceFederal could adversely affect First Defiance’s business, financial condition, results of operations or prospects.

Failure to integrate or adopt new technology may undermine First Defiance’s ability to meet customer demands, leading to adverse effects on First Defiance’s financial condition and results of operations.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. First Defiance’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in operations. First Defiance may not be able to effectively implement or have the resources to implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could adversely affect First Defiance’s business, financial condition, or results of operations.

A transition away from LIBOR as a reference rate for financial contracts could negatively affect First Defiance’s income and expenses and the value of various financial contracts.

LIBOR is used extensively in the U.S. and globally as a benchmark for various commercial and financial contracts, including adjustable rate mortgages, corporate debt, interest rate swaps and other derivatives. LIBOR is set based on interest rate information reported by certain banks, which may stop reporting such information after 2021. It is uncertain at this time whether LIBOR will change or cease to exist or the extent to which those entering into financial contracts will transition to any other particular benchmark. Other benchmarks may perform differently than LIBOR or alternative benchmarks have performed in the past or have other consequences that cannot currently be anticipated. It is also uncertain what will happen with instruments that rely on LIBOR for future interest rate adjustments and which remain outstanding if LIBOR ceases to exist.

First Defiance may be the subject of litigation, which would result in legal liability and damage to its business and reputation.

From time to time, First Defiance may be subject to claims or legal action from customers, employees or others. Financial institutions like First Defiance are facing a growing number of significant class actions, including those based on the manner of calculation of interest on loans and the assessment of overdraft fees. Future litigation could include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. First Defiance is also involved from time to time in other reviews, investigations and proceedings (both formal and informal) by governmental and other agencies regarding its businesses. These matters also could result in adverse judgments, settlements, fines, penalties, injunctions or other relief. Like other financial institutions, First Defiance is also subject to risk from potential employee misconduct, including non-compliance with policies and improper use or disclosure of confidential information. Substantial legal liability or significant regulatory action against First Defiance could materially adversely affect its business, financial condition or results of operations and/or cause significant reputational harm to its business.

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Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

At December 31, 2016,2018, First Federal conducted its business from its main office at 601 Clinton Street,St., Defiance, Ohio, and thirty-three43 other full-service banking centers in northwest and central Ohio, northeast Indiana and southeast Michigan as well as a loan production office in southeast Michigan. First Insurance conducted its business primarily from leased office space at 511 Fifth Street, Defiance, Ohio; 209 West Poe Road, Bowling Green, Ohio; 204 East High Street, Bryan, Ohio; 1755 Indian Wood Circle, Maumee, Ohio; 4350 Navarre Ave, Oregon, Ohio and 2600 Allentown Road, Lima,nine offices in northwest Ohio.

 

In August 2016,October 2018, First Federal received approval to transition its loan production officeopened a branch located at 4501 Cemetery Road, Hilliard, Ohio to a full-service branch. The transition will be completed late in the first quarter of 2017.203 E. Berry St., Fort Wayne, Indiana. This office is owned.leased.

 

First Defiance maintains its headquarters in the main office of First Federal at 601 Clinton Street,St., Defiance, Ohio. Back-office operation departments, including information technology, loan processing and underwriting, deposit processing, accounting and risk management are headquartered in an operations center located at 25600 Elliott Road,Rd., Defiance, Ohio.

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The following table sets forth certain information with respect to the offices and other properties of the Company at December 31, 2016.2018. See Note 9 to the Consolidated Financial Statements.

 

 Leased/ Net Book Value     Leased/ Net Book Value    
Description/address Owned of Property  Deposits  Owned of Property  Deposits 
   (In Thousands)    (In Thousands) 
Main Office, First Federal          
601 Clinton St., Defiance, OH Owned $3,225  $230,654 
Operations Center          
25600 Elliott Rd., Defiance, OH Owned  4,807   N/A 
Mobile Banking          
1011 W. Beecher St., Adrian, MI Owned  170   N/A 
First Federal          
Main Office - 601 Clinton St., Defiance, OH Owned $2,908  $268,657 
Operations Center - 25600 Elliott Rd., Defiance, OH Owned  4,495   N/A 
Branch Offices, First Federal                    
204 E. High St., Bryan, OH Owned  538   157,476  Owned  490   160,615 
211 S. Fulton St., Wauseon, OH Owned  345   75,865  Owned  282   75,492 
625 Scott St., Napoleon, OH Owned  877   79,074  Owned  778   97,500 
1050 E. Main St., Montpelier, OH Owned  225   43,705  Owned  216   52,327 
1800 Scott St., Napoleon, OH Owned  1,126   32,747  Owned  1,030   42,728 
1177 N. Clinton St., Defiance, OH Owned, Land Lease  730   41,753  Owned, Land Lease Leased  634   45,905 
905 N. Williams St., Paulding, OH Owned  653   85,946  Owned  593   92,873 
201 E. High St., Hicksville, OH Owned  288   29,753  Owned  250   36,928 
3900 N. Main St., Findlay, OH Owned  813   56,206  Owned  731   64,763 
1694 N. Countyline St., Fostoria, OH Owned  561   53,499  Owned  510   61,838 
1226 W. Wooster St., Bowling Green, OH Owned  877   113,248  Owned  810   129,991 
301 S. Main St., Findlay, OH Owned  786   66,427  Owned  669   107,898 
405 E. Main St., Ottawa, OH Owned  279   92,914  Owned  250   97,812 
124 E. Main St., McComb, OH Owned  160   22,646  Owned  142   22,156 
7591 Patriot Dr., Findlay, OH Owned  1,029   45,127  Owned  972   55,377 
417 W. Dussel Dr., Maumee, OH Owned, Land Lease  707   76,061  Owned, Land Lease  624   101,954 
230 E. Second St., Delphos, OH Owned  862   98,143  Owned  777   108,086 
105 S. Greenlawn Ave., Elida, OH Owned  284   42,443  Owned  276   44,050 
2600 Allentown Rd., Lima, OH Owned  929   44,419  Owned  866   51,231 
22020 W. State Rt. 51, Genoa, OH Owned  736   33,705  Owned  674   37,187 
3426 Navarre Ave., Oregon, OH Owned  810   38,547  Owned  744   42,202 
1077 Louisiana Ave., Perrysburg, OH Owned  389   41,871  Owned  477   50,288 
2565 Shawnee Rd., Lima, OH Owned  1,253   39,393  Owned  1,151   44,475 
1595 W. Dupont Rd., Fort Wayne, IN Leased  -   19,549  Leased  -   33,692 
135 S. Main St., Glandorf, OH Leased  -   16,474  Leased  -   19,395 
300 N. Main St., Adrian, MI Owned  613   82,230 
1701 W. Maumee St., Adrian, MI Owned  190   47,233 
211 W. Main St., Morenci, MI Owned  165   30,416 
539 S. Meridian Hwy., Hudson, MI Owned  494   45,950 
1449 W. Chicago Blvd., Tecumseh, MI Owned  1,384   59,648 
1200 N. Main St., Bowling Green OH Owned  1,558   10,093 
9909 Illinois Rd, Fort Wayne, IN Owned  1,931   26,915 
4501 Cemetery Rd, Hilliard, OH Owned  966   270 
2920 W. Central Ave., Toledo, OH Owned  165   1,228 
          
First Insurance Group          
511 Fifth St., Defiance, OH Leased  463   N/A 
209 W. Poe Rd., Bowling Green, OH Leased  -   N/A 
204 E. High St., Bryan, OH Leased  -   N/A 
1755 Indian Wood Cir., Maumee, OH Leased  -   N/A 
4350 Navarre Ave., Oregon, OH Leased  -   N/A 
2600 Allentown Rd., Lima, OH Leased  -   N/A 
   $31,388  $1,981,628 

 

 - 2933 - 

 

 

300 N. Main St., Adrian, MI Owned  646   85,995 
1701 W. Maumee St., Adrian, MI Owned  178   50,110 
211 W. Main St., Morenci, MI Owned  150   36,192 
539 S. Meridian Hwy., Hudson, MI Owned  453   49,559 
1449 W. Chicago Blvd., Tecumseh, MI Owned  1,325   64,201 
1200 N. Main St., Bowling Green OH Owned  1,508   14,884 
9909 Illinois Rd, Fort Wayne, IN Owned  1,859   56,102 
4501 Cemetery Rd, Hilliard, OH Owned  928   9,970 
2920 W. Central Ave., Toledo, OH Owned  158   2,073 
118 S. Sandusky Ave., Upper Sandusky, OH Owned  1,106   121,574 
112 E. Liberty St., Arlington, OH Owned  83   20,610 
128 S. Vance St., Carey, OH Owned  167   54,926 
17480 Cherokee St., Harpster, OH Owned  132   12,662 
279 Jamesway Dr., Marion, OH Owned  686   36,909 
195 Barks Rd. West, Marion, OH Owned  613   41,947 
1707 Cherry St., Toledo, OH Owned  56   9,145 
1995 Highland Dr., Suite A, Ann Arbor, MI Leased  -   - 
5520 Monroe St., Sylvania, OH Leased  16   7,669 
203 E. Berry St., Fort Wayne, IN Leased  26   934 
           
First Insurance Group          
511 Fifth St., Defiance, OH Leased  409   N/A 
209 W. Poe Rd., Bowling Green, OH Leased  -   N/A 
204 E. High St., Bryan, OH Leased  -   N/A 
2600 Allentown Rd., Lima, OH Leased  -   N/A 
107 Ditto St., Suite 400, Archbold, OH Leased  -   N/A 
101 W. Sandusky St., Suite 306, Findlay, OH Leased  -   N/A 
1650 N. Countyline St., Suite 200, Fostoria, OH Leased  -   N/A 
643 Miami St., Suite 5, Tiffin, OH Leased  -   N/A 
5520 Monroe St., Suite A, Sylvania, OH Leased  -   N/A 
    $31,848  $2,620,882 

Item 3. Legal Proceedings

Item 3.Legal Proceedings

 

First Defiance is involved in routine legal proceedings that are incidental to and occur in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition of First Defiance.

 

Item 4. Mine Safety Disclosures

Item 4.Mine Safety Disclosures

 

Not applicable.

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Item 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The Company’s common shares trade on The NASDAQ Global Select Market under the symbol “FDEF.” As of February 20, 2017,January 31, 2019, the Company had approximately 1,7822,347 shareholders of record.

The table below shows the reported high and low sales prices of the common shares and cash dividends declared per common share during the periods indicated in 2016 and 2015.

  Year Ending 
  December 31, 2016  December 31, 2015 
  High  Low  Dividend  High  Low  Dividend 
                   
Quarter ended:                        
March 31 $40.98  $34.80  $0.22  $34.64  $29.05  $0.175 
June 30  41.21   37.53   0.22   38.21   32.42   0.20 
September 30  46.83   35.90   0.22   39.95   35.03   0.20 
December 31  52.31   36.91   0.22   42.46   35.01   0.20 

 

The line graph below compares the yearly percentage change in cumulative total shareholder return on First Defiance common shares and the cumulative total return of the NASDAQ Composite Index, the SNL NASDAQ Bank Index and the SNL Midwest Thrift Index. An investment of $100 on December 31, 2011,2013, and the reinvestment of all dividends are assumed. The performance graph represents past performance and should not be considered to be an indication of future performance.

 

 - 3034 - 

 

 

 Period Ending     Period Ending    
Index 12/31/11  12/31/12  12/31/13  12/31/14  12/31/15  12/31/16  12/31/13  12/31/14  12/31/15  12/31/16  12/31/17  12/31/18 
First Defiance Financial Corp.  100.00   133.10   183.16   245.58   278.23   381.92   100.00   134.08   151.90   208.51   217.83   210.01 
NASDAQ Composite  100.00   117.45   164.57   188.84   201.98   219.89   100.00   114.75   122.74   133.62   173.22   168.30 
SNL Bank NASDAQ  100.00   119.19   171.31   177.42   191.53   265.56   100.00   103.57   111.80   155.02   163.20   137.56 
SNL Midwest Thrift  100.00   129.30   159.45   182.24   223.15   268.71   100.00   114.29   139.95   168.52   160.27   146.29 

 

 

The following table provides information regarding First Defiance’s purchases of its common shares during the fourth quarter period ended December 31, 2016:2018:

 

Period Total Number
of Shares
Purchased
  Average
Price Paid
Per Share
  Total Number of
Shares
Purchased as
Part of Publicly
Announced Plans
or Programs
  Maximum Number of
Shares (or Approximate
Dollar Value) that May
Yet Be Purchased Under
the Plans or Programs
(1)
 
October 1 – October 31, 2016  -  $-   -   377,500 
November 1 – November 30, 2016  -   -   -   377,500 
December 1 – December 31, 2016  122   50.74   -   377,500 
Total  122  $50.74   -   377,500 
Period Total Number
of Shares
Purchased
  Average
Price Paid
Per Share
  Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans
or Programs
  Maximum Number of
Shares (or Approximate
Dollar Value) that May
Yet Be Purchased Under
the Plans or Programs (1)
 
October 1 – October 31, 2018  -  $-   -   755,000 
November 1 – November 30, 2018  145,422   27.63   145,422   609,578 
December 1 – December 31, 2018  85,738   26.96   85,738   523,840 
Total  231,160  $27.38   231,160   523,840 

 

(1)On January 29, 2016, the Company announced that its Board of Directors authorized anothera program for the repurchase of up to 5% of the outstanding common shares or 450,000900,000 shares. There is no expiration date for the new repurchase program.

 

- 31 -

The information set forth under thecaptionthe caption “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters- Equity Compensation Plans”of this Form 10-K is incorporated herein by reference.

 

 - 3235 - 

 

 

Item 6.Selected Financial Data

 

The following table is derived from the Company’s audited financial statements as of and for the five years ended December 31, 2016.2018. The following consolidated selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes included elsewhere in this Form 10-K. The operating results of acquired companies are included with the Company’s results of operations since their respective dates of acquisition.

 

 As of and For the Year Ended December 31  As of and For the Year Ended December 31 
 2016  2015  2014  2013  2012  2018  2017  2016  2015  2014 
 (Dollars in Thousands, Except Per Share Data)  (Dollars and Shares in Thousands, Except Per Share Data) 
Financial Condition:                                        
Total assets $2,477,597  $2,297,676  $2,178,952  $2,137,148  $2,046,948  $3,182,376  $2,993,403  $2,477,597  $2,297,676  $2,178,952 
Investment securities  251,176   236,678   239,634   198,557   194,609   294,602   261,298   251,176   236,678   239,634 
Loans receivable, net  1,914,603   1,776,835   1,622,020   1,555,498   1,498,546   2,511,708   2,322,030   1,914,603   1,776,835   1,622,020 
Allowance for loan losses  25,884   25,382   24,766   24,950   26,711   28,331   26,683   25,884   25,382   24,766 
Nonperforming assets (1)  14,803   17,582   30,311   33,706   36,375 
Non-performing assets (1)  20,221   32,247   14,803   17,582   30,311 
Deposits and borrowers’ escrow balances  1,984,278   1,838,811   1,763,122   1,737,311   1,668,945   2,624,534   2,440,581   1,984,278   1,838,811   1,763,122 
FHLB advances  103,943   59,902   21,544   22,520   12,796   85,189   84,279   103,943   59,902   21,544 
Stockholders’ equity  293,018   280,197   279,505   272,147   258,128   399,589   373,286   293,018   280,197   279,505 
Share Information:                                        
Basic earnings per share  3.21   2.87   2.55   2.28   1.86  $2.27  $1.62  $1.61  $1.44  $1.28 
Diluted earnings per share  3.19   2.82   2.44   2.19   1.81   2.26   1.61   1.60   1.41   1.22 
Book value per common share  32.62   30.78   30.17   27.91   26.44   19.81   18.38   16.31   15.39   15.09 
Tangible book value per common share (2)  25.59   23.79   23.25   21.22   19.63   14.71   13.24   12.80   11.89   11.62 
Cash dividends per common share  0.88   0.775   0.625   0.40   0.20   0.64   0.50   0.44   0.39   0.31 
Dividend payout ratio  27.41%  27.00%  24.51%  17.45%  10.75%  28.19%  30.96%  27.41%  27.00%  24.51%
Weighted average diluted shares outstanding  9,035   9,371   9,969   10,171   9,998   20,468   20,056   18,070   18,742   19,938 
Shares outstanding end of period  8,983   9,102   9,235   9,720   9,729   20,171   20,312   17,966   18,204   18,470 
Operations:                                        
Interest income $87,383  $80,836  $76,248  $74,781  $80,943  $124,717  $108,102  $87,383  $80,836  $76,248 
Interest expense  8,440   6,781   6,559   7,170   11,937   16,462   11,431   8,440   6,781   6,559 
Net interest income  78,943   74,055   69,689   67,611   69,006   108,255   96,671   78,943   74,055   69,689 
Provision for loan losses  283   136   1,117   1,824   10,924   1,176   2,949   283   136   1,117 
Non-interest income  34,030   31,803   31,641   30,778   34,374 
Non-interest expense  71,093   67,889   66,758   65,052   65,780 
Noninterest income  39,208   40,081   34,030   31,803   31,641 
Noninterest expense  89,412   85,351   71,093   67,889   66,758 
Income before tax  41,597   37,833   33,455   31,513   26,676   56,875   48,452   41,597   37,833   33,455 
Federal income tax  12,754   11,410   9,163   9,278   8,012   10,626   16,184   12,754   11,410   9,163 
Net Income  28,843   26,423   24,292   22,235   18,664   46,249   32,268   28,843   26,423   24,292 
Performance Ratios:                                        
Return on average assets  1.20%  1.19%  1.12%  1.08%  0.90%  1.52%  1.13%  1.20%  1.19%  1.12%
Return on average equity  10.10%  9.52%  8.78%  8.39%  6.99%  12.03%  9.19%  10.10%  9.52%  8.78%
Interest rate spread (2)  3.61%  3.71%  3.57%  3.65%  3.64%  3.79%  3.74%  3.61%  3.71%  3.57%
Net interest margin (2)  3.74%  3.81%  3.68%  3.76%  3.81%  3.98%  3.88%  3.74%  3.81%  3.68%
Ratio of operating expense to                    
average total assets  2.97%  3.05%  3.09%  3.16%  3.19%
Ratio of operating expense to average total assets  2.93%  2.99%  2.97%  3.05%  3.09%
Efficiency ratio (2)  62.20%  63.01%  65.32%  64.81%  63.93%  60.29%  61.81%  62.20%  63.01%  65.32%
Other Ratios:                                        
Equity to total assets at end of period  11.83%  12.19%  12.83%  12.73%  12.61%  12.56%  12.47%  11.83%  12.19%  12.83%
Average equity to average assets  11.91%  12.49%  12.79%  12.92%  12.95%  12.61%  12.32%  11.91%  12.49%  12.79%
Asset Quality Ratios:                                        
Nonperforming assets to total assets                    
at end of period (1)  0.60%  0.77%  1.39%  1.58%  1.78%
Allowance for loan losses to total                    
loans*  1.33%  1.41%  1.50%  1.58%  1.75%
Non-performing assets to total assets at end of period (1)  0.64%  1.08%  0.60%  0.77%  1.39%
Allowance for loan losses to total loans*  1.12%  1.14%  1.33%  1.41%  1.50%
Net charge-offs (recoveries) to average loans  -0.01%  -0.03%  0.08%  0.23%  1.18%  -0.02%  0.10%  -0.01%  -0.03%  0.08%

 

(1)NonperformingNon-performing assets include non-accrual loans that are contractually past due 90 days or more and real estate, mobile homes and other assets acquired by foreclosure or deed-in-lieu thereof.
(2)Refer to Non-GAAP Financial Measures in Item 7- Management’s Discussion and Analysis of Financial Condition and Results of Operations.
*Total loans are net of undisbursed loan funds and deferred fees and costs.

* Total loans are net of undisbursed loan funds and deferred fees and costs.

 

 - 3336 - 

 

 

Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements and Factors that Could Affect Future Results

 

Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in the Company’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Corporation that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per common share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of First Defiance or its management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

 

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

 

·Local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company’s assessment of that impact.

 

·Volatility and disruption in national and international financial markets.

 

·Government intervention in the U.S. financial system.

 

·Changes in the level of non-performing assets and charge-offs.

 

·Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.

 

·The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve.

 

·Inflation, interest rate, securities market and monetary fluctuations.

 

·Political instability.

 

·Acts of God or of war or terrorism.

 

·The timely development and acceptance of new products and services and perceived overall value of these products and services by users.

 

·Changes in consumer spending, borrowing and saving habits.

 

·Changes in the financial performance and/or condition of the Company’s borrowers.borrowers or customers.

 

·Technological changes including core system conversions.

 

·Acquisitions and integration of acquired businesses.

 

·The ability to increase market share and control expenses.

 

·Changes in the competitive environment among financial holding companies and other financial service providers.

 

·The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and the Subsidiariesits subsidiaries must comply.

 

 - 3437 - 

 

 

·The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board (“PCAOB”), the Financial Accounting Standards Board (“FASB”) and other accounting standard setters.

 

·The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews.

 

·Greater than expected costs or difficulties related to the integration of new products and lines of business.

 

·The Company’s success at managing the risks involved in the foregoing items.

 

Forward-looking statements speak only as of the date on which such statements are made. The Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

 

The following sectionThis Item 7 presents information to assess the financial condition and results of operations of First Defiance. This sectionitem should be read in conjunction with the Consolidated Financial Statements and the supplemental financial data contained elsewhere in this Annual Report on Form 10-K.

 

Non-GAAP Financial Measures

 

This documentAnnual Report on Form 10-K contains GAAP financial measures and certain non-GAAP financial measures which are presented as managementmeasures. Management believes theythat these measures are helpful in understanding the Company’s results of operations or financial position. Fully taxable-equivalent (“FTE”) is an adjustment to net interest income to reflect tax-exempt income on an equivalent before-tax basis. The following tables present a reconciliation of non-GAAP measures to their respective GAAP measures at December 31, 20162018 and 2015.2017.

 

Non-GAAP Financial Measures – Net Interest Income on an
FTE basis, Net Interest Margin and Efficiency Ratio
      
($ in Thousands) December 31,  
2016
  December 31,
2015
 
Net interest income (GAAP) $78,943  $74,055 
Add:  FTE adjustment  1,830   1,905 
Net interest income on a FTE basis (1) $80,773  $75,960 
         
Noninterest income – less securities gains/losses (2) $33,521  $31,781 
Noninterest expense (3)  71,093   67,889 
Average interest-earning assets less average unrealized gains/losses on securities(4)  2,160,561   1,993,311 
Average interest-earning assets  2,153,076   1,986,145 
Average unrealized gains/losses on securities  7,485   7,166 
         
Ratios:        
Net interest margin (1) / (4)  3.74%  3.81%
Efficiency ratio (3) / (1) + (2)  62.20%  63.01%

Non-GAAP Financial Measures – Net Interest Income on an

FTE basis, Net Interest Margin and Efficiency Ratio

(In Thousands) December 31,
2018
  December 31,
2017
 
Net interest income (GAAP) $108,255  $96,671 
Add:  FTE adjustment  1,004   1,914 
Net interest income on a FTE basis (1) $109,259  $98,585 
         
Noninterest income – less securities gains/(losses) (2) $39,035  $39,497 
Noninterest expense (3)  89,412   85,351 
Average interest-earning assets less average unrealized gains/(losses) on securities(4)  2,744,752   2,542,129 
      Average interest-earning assets  2,741,215   2,545,261 
      Average unrealized gains/losses on securities  (3,537)  3,132 
         
Ratios:        
Net interest margin (1) / (4)  3.98%  3.88%
Efficiency ratio (3) / (1) + (2)  60.29%  61.81%

 

Non-GAAP Financial Measures – Tangible Book Value

($ in Thousands, except per share data) December 31,  
2016
  December 31,
2015
 
(In Thousands, except per share data) December 31,
2018
  December 31,
2017
 
Total Shareholders’ Equity (GAAP) $293,018  $280,197  $399,589  $373,286 
Less: Goodwill  (61,798)  (61,798)  (98,569)  (98,569)
Intangible assets  (1,336)  (1,871)  (4,391)  (5,703)
Tangible common equity (1) $229,884  $216,528  $296,629  $269,014 
        
Common shares outstanding (2)  8,983   9,102   20,171   20,312 
        
Tangible book value per share (1) / (2) $25.59  $23.79  $14.71  $13.24 

 

 - 3538 - 

 

 

Overview

 

First Defiance is a unitary thrift holding company that conducts business through the Subsidiaries,its wholly-owned subsidiaries, First Federal, First Insurance and First Defiance Risk Management.

 

First Federal is a federally chartered stock savings bank that provides financial services to communities based in northwest Ohio, northeast Indiana, and southeastern Michigan where it operates 3444 full service banking centers in twelvefourteen northwest and central Ohio counties, one northeast Indiana county, and one southeastern Michigan county. First Federal operates one loan production office in one central Ohio county,Ann Arbor, Michigan, which will become a full-service branch lateis located in the first quarter of 2017.Washtenaw County.

 

First Federal provides a broad range of financial services including checking accounts, savings accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity loans and trust and wealth management services through its extensive branch network.

 

First Insurance sells a variety of property and casualty, group health and life and individual health and life insurance products. First Insurance is an insurance agency that doesconducts business in the Defiance, Bryan, Bowling Green, Lima,throughout First Federal’s Markets. The previous Maumee and Oregon, Ohio areas.offices were consolidated into a new office in Sylvania, Ohio, in January 2018.

 

First Defiance Risk Management is a wholly owned insurance company subsidiary of the Company to insure the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. First Defiance Risk Management was incorporated on December 20, 2012.

 

On June 22, 2018, the Company announced a stock split in the form of a share distribution of two common shares for each outstanding common share. The stock split was distributed on July 12, 2018, to shareholders of record as of July 2, 2018. All share and per share data in this Form 10-K have been adjusted and are reflective of the stock split.

Financial Condition

 

Assets at December 31, 20162018, totaled $2.48$3.18 billion compared to $2.30$2.99 billion at December 31, 2015,2017, an increase of $179.9$188.3 million or 7.8%6.3%. Cash and cash equivalents increased $19.2 million to $99.0 million at December 31, 2016 from $79.8 million at December 31, 2015. The increase in assets was primarily due to an increase in loans receivable, net of undisbursed loan funds and deferred fees and costs, of $138.3$191.3 million, and an increase in securities of $14.5$33.3 million. These increases were funded primarily by increasesan increase in total deposits of $145.5 million and advances from the Federal Home Loan Bank of $44.0 million as well as from cash and cash equivalents.$183.2 million.

 

Securities

 

The securities portfolio increased $14.5$33.3 million to $251.2$294.6 million at December 31, 2016.2018. The 20162018 activity in the portfolio included $71.3$76.6 million of purchases, $882,000which were partially offset by $1.2 million of amortization,, $36.4 $32.7 million of principal pay-downs and maturities, and $14.9$5.5 million of securities being sold. There was a net decreaseloss of $5.4$3.5 million in the market value of available-for-sale securities. For additional information regarding First Defiance’s investment securities see Note 5 to the Consolidated Financial Statements.

 

- 39 -

Loans

 

Loans receivable, net of undisbursed loan funds and deferred fees and costs, increased $138.3$191.3 million to $1.94$2.54 billion at December 31, 2016.2018. For more details on the loan balances, see Note 7 – Loans Receivable in the Notes to the Consolidated Financial Statements.

 

The majority of First Defiance’s commercial real estate and commercial loans are to smallsmall- and mid-sized businesses. The combined commercial, commercial real estate and multi-family real estate loan portfolios totaled $1.51$1.85 billion and $1.37$1.76 billion at December 31, 20162018 and 2015,2017, respectively, and accounted for approximately 74.2%71.8% and 73.1%71.4% of First Defiance’s loan portfolio at the end of those respective periods. First Defiance believes it has been able to establish itself as a leader in its market area in the commercial and commercial real estate lending area by hiring experienced lenders and providing a high level of customer service to its commercial lending clients.

 

- 36 -

The 1-4 family residential portfolio totaled $207.6$322.7 million at December 31, 2016,2018, compared with $205.3$274.9 million at the end of 2015.2017. At the end of 2016,2018, those loans comprised 10.2%12.1% of the total loan portfolio, downup from 11.0%11.1% at December 31, 2015.2017.

 

Construction loans, which include one-to-four family and commercial real estate properties, increased to $182.9$265.8 million at December 31, 20162018, compared to $163.9$265.5 million at December 31, 2015.2017. These loans accounted for approximately 9.0%10.0% and 8.7%10.8% of the total loan portfolio at December 31, 20162018 and 2015,2017, respectively.

 

Home equity and home improvement loans increaseddecreased to $118.4$128.2 million at December 31, 2016,2018, from $117.0$135.5 million at the end of 2015.2017. At the end of 2016,2018, those loans comprised 5.8%4.8% of the total loan portfolio, down slightly from 6.3%5.5% at December 31, 2015.2017.

 

Consumer finance and mobile home loans were $16.7$34.4 million at December 31, 20162018 up slightly from $16.3$29.1 million at the end of 2015.2017. These loans accounted for approximately 0.8%1.3% and 0.9%1.2% of the total loan portfolio at December 31, 20162018 and 2015,2017, respectively.

 

In order to properly assess the collateral dependent loans included in its loan portfolio, the Company has established policies regarding the monitoring of the collateral underlying such loans. The Company requires an appraisal that is less than one year old for all new collateral dependent real estate loans, and all renewed collateral dependent real estate loans where significant new money is extended. The appraisal process is handled by the Credit Department, which selects the appraiser and orders the appraisal. First Defiance’s loan policy prohibits the account officer from talking or communicating with the appraiser to insure that the appraiser is not influenced by the account officer in any way in making a determination of value.

 

First Federal generally does not require updated appraisals for performing loans unless significant new money is requested by the borrower.

 

When a collateral dependent loan is downgraded to classified status, First Federal reviews the most current appraisal on file and if appropriate, based on First Federal’s assessment of the appraisal, such as age, market, etc. First Federal will discount the appraisal amount to a more appropriate current value based on inputs from lenders and realtors. This amount may then be discounted further by First Federal’s estimation of the selling costs. In most instances, if the appraisal is more than twelve to fifteen months old, a new appraisal may be required. Finally, First Federal assesses whether there is any collateral short fall, taking into consideration guarantor support and liquidity, and determines if a charge offcharge-off is necessary.

 

All loans over 90 days past due and/or on non-accrual are classified as non-performing loans. Non-performing status automatically occurs in the month in which the 90-day delinquency occurs. When a collateral dependent loan moves to non-performing status, First Federal generally gets a new third party appraisal and charges the loan down appropriately based upon the new appraisal and an estimate of costs to liquidate the collateral. All properties that are moved into the Other Real Estate Owned (“OREO”) category are supported by current appraisals, and the OREO is carried at the lower of cost or fair value, which is determined based on appraised value less First Federal’s estimate of the liquidation costs.

 

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First Federal does not adjust any appraisals upward without written documentation of this valuation change from the appraiser. When setting reserves and charge offscharge-offs on classified loans, appraisal values may be discounted downward based upon First Federal’s experience with liquidating similar properties.

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Appraisals are received within approximately 60 days after they are requested. The First Federal Loan Loss Reserve Committee reviews the amount of each new appraisal and makes any necessary charge offcharge-off decisions at its meeting prior to the end of each quarter.

 

Any partially charged-off collateral dependent loans are considered non-performing, and as such, would need to show an extended period of time with satisfactory payment performance as well as cash flow coverage capability supported by current financial statements before First Federal will consider an upgrade to performing status. First Federal may consider moving the loan to accruing status after approximately six months of satisfactory payment performance.

 

For loans where First Federal determines that an updated appraisal is not necessary, other means are used to verify the value of the real estate, such as recent sales of similar properties on which First Federal had loans as well as calls to appraisers, brokers, realtors and investors. First Federal monitors and tracks its loan to value quarterly to determine accuracy and any necessary charge offs.charge-offs. Based on these results, changes may occur in the processes used.

 

Loan modifications constitute a troubled debt restructuring (“TDR”) if First Federal, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. For loans that are considered TDRs and the balance is over $250,000, First Federal either computes the present value of expected future cash flows discounted at the original loan’s effective interest rate or it may measure impairment based on the fair value of the collateral. For those loans measured for impairment utilizing the present value of future cash flows method, any discount is carried as a specific reserve in the allowance for loan and lease losses. For those loans measured for impairment utilizing the fair value of the collateral, any shortfall is charged off.charged-off. For loans that are considered TDRs and the balance is under $250,000 a specific reserve is carried in the allowance for loan and lease losses based on a general reserve analysis. As of December 31, 20162018, and December 31, 2015,2017, First Federal had $10.5$11.6 million and $11.2$13.8 million, respectively, of loans that were still performing and which were classified as TDRs.

 

Allowance for Loan Losses

 

The allowance for loan losses represents management’s assessment of the estimated probable incurred credit losses in the loan portfolio at each balance sheet date. Management analyzes the adequacy of the allowance for loan losses regularly through reviews of the loan portfolio. Consideration is given to economic conditions, changes in interest rates and the effect of such changes on collateral values and borrower’s ability to pay, changes in the composition of the loan portfolio and trends in past due and non-performing loan balances. The allowance for loan losses is a material estimate that is susceptible to significant fluctuation and is established through a provision for loan losses based on management’s evaluation of the inherent risk in the loan portfolio. In addition to extensive in-house loan monitoring procedures, the Company utilizes an outside party to conduct an independent loan review of commercial loan and commercial real estate loan relationships. The goal is to have approximately 55% to 60% of the portfolio reviewed annually. This includes all relationships over $5.0 million with new exposure greater than $2.0 million and a sample of other relationships greater than $5.0 million; loan relationships between $1.0 million and $5.0 million with new exposure greater than $750,000 and a sample of other relationships between $1.0 million and $5.0 million; and a sample of relationships less than $1.0 million. Management utilizes the results of this outside loan review to assess the effectiveness of its internal loan grading system as well as to assist in the assessment of the overall adequacy of the allowance for loan losses associated with these types of loans.

 

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The allowance for loan loss is made up of two basic components. The first component of the allowance for loan loss is the specific reserve in which the Company sets aside reserves based on the analysis of individual impaired credits. In establishing specific reserves, the Company analyzes all substandard, doubtful and loss graded loans quarterly and makes judgments about the risk of loss based on the cash flow of the borrower, the value of any collateral and the financial strength of any guarantors. If the loan isFor loans that are considered impaired and cash flow dependent, then a specific reservethe balance is established forover $250,000, First Federal either computes the discount on the net present value of expected future cash flows. Ifflows discounted at the original loan’s effective interest rate or it may measure impairment based on the fair value of the collateral. For those loans measured for impairment utilizing the present value of future cash flows method, any discount is carried as a specific reserve in the allowance for loan is impaired and lease losses. For those loans measured for impairment utilizing the fair value of the collateral, dependent, then any shortfall is usually charged off.charged-off. For loans that are considered impaired and the balance is under $250,000 a specific reserve is carried in the allowance for loan and lease losses based on a general reserve analysis. The Company also considers the impacts of any Small Business Association or Farm Service Agency guarantees. The specific reserve was $809,000$595,000 at December 31, 20162018, and $437,000$758,000 at December 31, 2015.2017.

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The second component is a general reserve, which is used to record loan loss reserves for groups of homogenous loans in which the Company estimates the losses incurred in the portfolio based on quantitative and qualitative factors. For purposes of the general reserve analysis, the loan portfolio is stratified into nine different loan pools based on loan type to allocate historic loss experience. The loss experience factor is then applied to the non-impaired loan portfolio. Beginning June 30, 2015, theThe Company refined the methodology to its allowance for loan loss calculation pertaining to the general reserve component for non-impaired loans. There was no change to the calculation of the component for reserves on impaired loans. Within the general reserve, the determination of the historical loss component was modified from using a three-year average annual loss rate to autilizes loss migration measurement. The loss migration measurement implemented June 30, 2015, utilized an average of four (4) four-year loss migration periods for each loan portfolio segment with differentiation between loan risk grades. Prior to June 30, 2015,grades in calculating the approach to thisgeneral reserve component quantified the historical loss by calculating a rolling twelve quarter average annual loss rate for each portfolio segment, without differentiation between loan risk grades.non-impaired loans. Beginning December 31, 2016, the historical loss calculation was changed from using a an average of four (4) four-year loss migration periods to using an average of all four-year loss migration periods to the present beginning with data from the second quarter 2011. Management believes this enhancement is consistent with the rationale of the previous measurement but provides a more precise calculation of historical losses by incorporating more data points for the average loss ratio and including periods that provide a more complete coverage of the full business cycle. Management believes that capturing the risk grade changes and cumulative losses over the life cycle of a loan more accurately depicts management’s estimate of historical losses as well as being more reflective of the ongoing risks in the loan portfolio. These modifications resulted in a change in the general reserves between the loan portfolio segments but did not have a material impact on the overall allowance for loan losses.

 

The stratification of the loan portfolio and the loss migration measurement described above resulted in a decrease to the quantitative general allowance to $8.7remained steady at $5.9 million at December 31, 20162018, from $9.8$6.0 million at December 31, 2015.2017, due to relatively small changes in the historical loss rates from the migration analysis.

 

In addition to the quantitative analysis, a qualitative analysis is performed each quarter to provide additional general reserves on the non-impaired loan portfolio for various factors. The overall qualitative factors are based on nine sub-factors. The nine sub-factors have been aggregated into three qualitative factors: economic, environment and risk.

 

ECONOMIC

1)Changes in international, national and local economic business conditions and developments, including the condition of various market segments.
2)Changes in the value of underlying collateral for collateral dependent loans.

 

ENVIRONMENT

3)Changes in the nature and volume in the loan portfolio.
4)The existence and effect of any concentrations of credit and changes in the level of such concentrations.
5)Changes in lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices.
6)Changes in the quality and breadth of the loan review process.
7)Changes in the experience, ability and depth of lending management and staff.

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RISK

8)Changes in the trends of the volume and severity of delinquent and classified loans, and changes in the volume of non-accrual loans, trouble debt restructuring, and other loan modifications.
9)Changes in the political and regulatory environment.

 

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The qualitative analysis at December 31, 20162018, indicated a general reserve of $16.4$21.8 million compared with $15.2$20.0 million at December 31, 2015.2017, an increase of $1.8 million. Management reviews the overall economic, environmental and risk factors quarterly and determines appropriate adjustments to these sub-factors based on that review.

 

The economic factors for all loan segments were increaseddecreased in 20162018 primarily due to the uncertain global economic conditions and related market volatility which presented higher than normal risks tostrengthening trends in the U.S. economy.economy, particularly unemployment rates, which decreased in all markets.

 

The environmental factors have increased in 2016 in the commercial real estate and commercial2018 for all loan segmentssegments. This is principally dueto the significant growth in balances achieved amidst highly competitive conditions on pricing and terms and balances generated in our metro markets. There was also a continuedan increase in the volume of loans greater than $10 millioncredit concentrations and an increase in loans to our most significant borrowers. The environmental factors for residential, consumer, home equity and construction loans were decreased during 2016 due to the stability and maturitymix of the lending staff.in First Federal’s defined metro markets.

 

The risk factors decreased in all2018 in most loan segments except consumer were decreasedwith the largest decrease being in 2016commercial. This is due to the continued decrease favorable trends in the levellevels of non-accrualnon-performing loans troubled debt restructurings and OREO since December 31, 2015.classified assets.

 

First Defiance’s general reserve percentages for main loan segments not otherwise classified ranged from 0.50%0.48% for construction loans to 1.71%1.50% for home equity and improvement loans.

 

As a result of the quantitative and qualitative analysis, along with the change in specific reserves, the Company’s provision for loan losses for 20162018 was $283,000$1.2 million compared to $136,000$2.9 million for 2015.2017. The allowance for loan losses was $25.9$28.3 million at December 31, 20162018, and $25.4$26.7 million at December 31, 20152017, and represented 1.33%1.12% and 1.41%1.14% of loans, net of undisbursed loan funds and deferred fees and costs, respectively. The decrease in the quantitative reserves and the lower level of charge offs was offset by the increase in the qualitative reserve and specific reserve. The provision was offset by charge offscharge-offs of $1.4$2.9 million and recoveries of $1.6$3.3 million resulting in an increase to the overall allowance for loan loss of $502,000.$1.6 million. In management’s opinion, the overall allowance for loan losses of $25.9$28.3 million as of December 31, 20162018, is adequate.

 

Management also assesses the value of OREO as of the end of each accounting period and recognizes write-downs to the value of that real estate in the income statement if conditions dictate. In 2016,2018, First Defiance recorded OREO write-downs that totaled $74,000.$552,000. These amounts were included in other non-interestnoninterest expense. Management believes that the values recorded at December 31, 20162018, for OREO and repossessed assets represent the realizable value of such assets.

 

Total classified loans decreased significantly to $27.5from $59.4 million at December 31, 2016, compared2017 to $49.1$50.8 million at December 31, 2015.2018, a reduction of $8.6 million, due to payoffs and an upgrade of a large classified relationship during 2018.

 

First Defiance’s ratio of allowance for loan losses to non-performing loans was 180.4%149.0% at December 31, 20162018, compared with 156.1%86.9% at December 31, 2015.2017. Management monitors collateral values of all loans included on the watch list that are collateral dependent and believes that allowances for those loans at December 31, 20162018, are appropriate.

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At December 31, 2016,2018, First Defiance had total non-performing assets of $14.8$20.2 million, compared to $17.6$32.2 million at December 31, 2015.2017. Non-performing assets include loans that are 90 days past due, real estate ownedOREO and other assets held for sale.

 

The decrease in non-performing assets between December 31, 20162018, and December 31, 20152017, is primarily in commercial loans and commercial real estate owned.loans. The balance of commercial non-performing loans was $2.1$4.3 million lower at December 31, 20162018, compared to December 31, 2015.2017. The balance of OREOcommercial real estate loans was $866,000$7.9 million lower at December 31, 20162018, compared to December 31, 2015.2017.

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Non-performing loans in the single-family1-4 family residential, commercial real estate and commercial loan categories represent 1.41%1.13%, 0.92%0.74% and 0.21%0.88% of the total loans in those categories respectively at December 31, 20162018, compared to 1.27%1.10%, 1.04%1.47% and 0.73%1.68% respectively for the same categories at December 31, 2015.2017. Management believes that the current allowance for loan losses is appropriate and that the provision for loan losses recorded in 20162018 is consistent with both charge-off experience and the risk inherent in the overall credits in the portfolio.

 

First Federal’s Asset Review Committee meets monthly to review the status of work-out strategies for all criticized relationships, which include all non-accrual loans. Based on such factors as anticipated collateral values in liquidation scenarios, cash flow projections, assessment of net worth of guarantors and all other factors which may mitigate risk of loss, the Asset Review Committee makes recommendations regarding proposed charge-offs which are approved by the Senior Loan Committee or the Loan Loss Reserve Committee.

 

ForThe net charge-offs and non-accrual loan balances as a percentage of total are presented in the twelve months ended and as oftable below at December 31, 2016, commercial real estate, which represented 51.15% of total loans, accounted for a net recovery of 379.45%2018 and 66.85% of nonaccrual loans, and commercial loans, which represented 23.01% of total loans, accounted for 127.85% of net charge offs and 7.02% of nonaccrual loans. For the twelve months ended and as of December 31, 2015, commercial real estate, which represented 50.71% of total loans, accounted for a net recovery of 93.33% and 60.56% of nonaccrual loans, and commercial loans, which represented 22.42% of total loans, accounted for 54.79% of net recoveries and 18.93% of nonaccrual loans.2017.

 

Table 1 – Net Charge-offs and Non-accruals by Loan Type

 

 For the Twelve Months Ended December 31, 2016  As of December 31, 2016  For the Twelve Months Ended December 31, 2018  As of December 31, 2018 
 Net % of Total Net       Net % of Total Net      
 Charge-offs Charge-offs Nonaccrual % of Total Non-  Charge-offs Charge-offs Non-accrual % of Total Non- 
 (Recoveries)  (Recoveries)  Loans  Accrual Loans  (Recoveries)  (Recoveries)  Loans  Accrual Loans 
 (In Thousands)   (In Thousands)    (In Thousands)   (In Thousands)   
Residential $184   84.02% $2,928   20.41% $130   27.54% $3,640   19.14%
Construction  -   0.00%  -   0.00%  -   0.00%  -   0.00%
Commercial real estate  (831)  (379.45)%  9,592   66.85%  610   129.24%  10,357   54.47%
Commercial  280   127.85%  1,007   7.02%  (1,497)  (317.16)%  4,500   23.66%
Consumer finance  30   13.70%  91   0.63%  207   43.85%  126   0.66%
Home equity and improvement  118   53.88%  730   5.09%  78   16.53%  393   2.07%
Total $(219)  (100.00)% $14,348   100.00% $(472)  100.00% $19,016   100.00%

 

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 For the Twelve Months Ended December 31, 2017 As of December 31, 2017 
 For the Twelve Months Ended December 31, 2015 As of December 31, 2015  Net % of Total Net     
 Net % of Total Net Nonaccrual % of Total Non-  Charge-offs Charge-offs Non-accrual % of Total Non- 
 Charge-offs Charge-offs Loans Accrual Loans  (Recoveries) (Recoveries) Loans Accrual Loans 
 (In Thousands)   (In Thousands)    (In Thousands)   (In Thousands)   
Residential $69   14.38% $2,610   16.05% $164   7.63% $3,037   9.89%
Construction  -   0.00%  -   0.00%  -   0.00%  -   0.00%
Commercial real estate  (448)  (93.33)%  9,848   60.56%  (260)  (12.09)%  18,219   59.32%
Commercial  (263)  (54.79)%  3,078   18.93%  2,058   95.77%  8,841   28.78%
Consumer finance  -   0.00%  36   0.22%  54   2.46%  28   0.09%
Home equity and improvement  162   33.74%  689   4.24%  134   6.23%  590   1.92%
Total $(480)  (100.00)% $16,261   100.00% $2,150   100.00% $30,715   100.00%

 

The following table sets forth information concerning the allocation of First Defiance’s allowance for loan losses by loan categories at December 31, 20162018 and 2015.2017.

 

Table 2 – Allowance for Loan Loss Allocation by Loan Category

 

 December 31, 2016  December 31, 2015  December 31, 2018  December 31, 2017 
    Percent of     Percent of     Percent of     Percent of 
    total loans     total loans     total loans     total loans 
 Amount  by category  Amount  by category  Amount  by category  Amount  by category 
 (Dollars in Thousands)  (Dollars in Thousands) 
1-4 family residential $2,627   10.2% $3,212   11.0% $2,881   12.1% $2,532   11.1%
Multi-family residential real estate  2,228   9.7   2,151   9.0   3,101   10.4   2,702   10.1 
Commercial real estate  10,625   41.5   11,772   41.8   12,041   42.3   10,354   40.0 
Construction  450   9.0   517   8.7   682   10.0   647   10.8 
Commercial loans  7,361   23.0   5,192   22.4   7,281   19.1   7,965   21.3 
Home equity and improvement loans  2,386   5.8   2,270   6.2   2,026   4.8   2,255   5.5 
Consumer loans  207   0.8   171   0.9   319   1.3   228   1.2 
 $25,884   100.0% $25,382   100.0% $28,331   100.0% $26,683   100.0%

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Loans Acquired with Impairment

 

CertainThe Company has purchased loans, acquired hadfor which there was, at acquisition, evidence that theof deterioration of credit quality of the loan had deteriorated since its origination and in management’s assessment at the acquisition date, it was probable, at acquisition, that First Defiance would be unable to collect all contractually required payments due. In accordance with FASB ASC Topic 310 Subtopic 30,Loans and Debt Securities Acquired with Deteriorated Credit Quality, these loans were recorded based on management’s estimate of the fair value of the loans.would not be collected.

 

As of December 31, 2016,2018, the total contractual receivable for those loans was $66,000$2.5 million and the recorded value was $11,000.$2.3 million.

 

High Loan-to-Value Mortgage Loans

 

The majority of First Defiance’s mortgage loans are collateralized by one-to-four-family residential real estate, have loan-to-value ratios of 80% or less, and are made to borrowers in good credit standing. First Federal usually requires residential mortgage loan borrowers whose loan-to-value is greater than 80% to purchase private mortgage insurance (“PMI”). Management also periodically reviews and monitors the financial viability of its PMI providers.

 

First Federal originates and retains a limited number of residential mortgage loans with loan-to-value ratios that exceed 80% where PMI is not required if the borrower possesses other demonstrable strengths. The loan-to-value ratios on these loans are generally limited to 85% and exceptions must be approved by First Federal’s senior loan committee.Chief Credit Officer. Management monitors the balance of one-to-four family residential loans, including home equity loans and committed lines of credit that exceed certain loan to value standards (90% for owner occupied residences, 85% for non-owner occupied residences and one-to-four family construction loans, 75% for developed land and 65% for raw land). Total loans that exceed those standards described above at December 31, 20162018, totaled $42.8$53.0 million, compared to $46.3$50.8 million at December 31, 2015.2017. These loans are generally paying as agreed.

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First Defiance does not make interest-only, first-mortgage residential loans, nor does it have residential mortgage loan products or other consumer products that allow negative amortization.

 

Goodwill and Intangible Assets

 

Goodwill was $61.8$98.6 million at December 31, 20162018, and December 31, 2015.2017. Core deposit intangibles and other intangible assets decreased to $1.3$4.4 million at December 31, 20162018, compared to $1.9$5.7 million at December 31, 2015.2017. During 2016,2018, changes to the core deposit intangibles and other intangibles were due to the recognition of $535,000$1.3 million of amortization expense. No impairment of goodwill was recorded in 20162018 or 2015.2017.

 

Deposits

 

Total deposits at December 31, 20162018, were $1.98$2.62 billion compared to $1.84$2.44 billion at December 31, 2015,2017, an increase of $145.5$183.2 million or 7.9%7.5%. Non-interest bearingNoninterest-bearing checking accounts grew by $67.0$35.8 million, interest bearinginterest-bearing checking accounts and money markets grew by $49.5$35.0 million, savings grewdecreased by $23.7$9.2 million and retail certificates of deposit grew by $5.3$121.6 million. Management can utilize the national market for certificates of deposit to supplement its funding needs if necessary. For more details on the deposit balances in general see Note 11 – Deposits in the Notes to the Consolidated Financial Statements.

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Borrowings

 

FHLB advances totaled $103.9$85.2 million at December 31, 20162018, compared to $59.9$84.3 million at December 31, 2015.2017. The balance at the end of 20162018 includes $5.0 million of convertible advances with a rate of 2.35%. This advance is callable by the FHLB, at which point it would convert to a three-month LIBOR advance if not paid off. This advance has a final maturity date in 2018. In addition, First Defiance has tenthirteen fixed-rate advances totaling $92.0$59.0 million with rates ranging from 0.99%1.14% to 2.16% and2.50%, one amortizing advance totaling $6.9of $1.2 million with a rate of 1.78%2.14% and one overnight advance of $25.0 million with a rate of 2.45%.

 

At December 31, 2016,2018, First Defiance also had $31.8$5.7 million of securities that were sold with agreements to repurchase, compared to $57.2$26.0 million at December 31, 2015.2017.

 

Equity

 

Total stockholders’ equity increased $12.8$26.3 million to $293.0$399.6 million at December 31, 2016. This2018, compared to $373.3 million at December 31, 2017. The increase is ain stockholders’ equity was the result of recording net income of $28.8 million and capital of $714,000 from the exercise of 37,970 net shares under stock option plans, which$46.2 million. This was partially offset by repurchasing 167,868the payment of $13.0 million of common stock dividends, the repurchase of 231,160 shares of common stock totaling $6.3 million and $7.9 millionother comprehensive loss of common stock dividends being paid in 2016. In 2015, 225,808 shares were repurchased, resulting in an $8.4 million decrease in stockholders’ equity, and 73,800 net shares were exercised under stock option plans resulting in a $1.5 million increase in stockholder’s equity.$2.4 million.

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Results of Operations

 

Summary

 

First Defiance reported net income of $28.8$46.2 million for the year ended December 31, 20162018, compared to $26.4$32.3 million and $24.3$28.8 million for the years ended December 31, 20152017 and 2014,2016, respectively. On a diluted per common share basis, First Defiance earned $3.19$2.26 in 2016, $2.822018, $1.61 in 20152017 and $2.44$1.60 in 2014.2016.

 

Net Interest Income

 

First Defiance’s net interest income is determined by its interest rate spread (i.e. the difference between the yields on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities.

 

Net interest income was $78.9$108.3 million for the year ended December 31, 20162018, compared to $74.1$96.7 million and $69.7$78.9 million for the years ended December 31, 20152017 and 2014,2016, respectively. The tax-equivalent net interest margin was 3.74%3.98%, 3.81%3.88% and 3.68%3.74% for the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively. The margin decreased 7increased 10 basis points between 20152017 and 2016.2018. The increase in margin in 2018 was primarily due to the increase in interest rates as the federal rate hikes impacted asset yields more favorably than deposit costs as well as the mix of our noninterest-bearing balances. Interest-earning asset yields decreased 2increased 26 basis points (to 4.13%4.59% in 20162018 from 4.15%4.33% in 2015)2017) and the cost of interestinterest- bearing liabilities between the two periods increased 821 basis points (to 0.52%0.80% in 20162018 from 0.44%0.59% in 2015)2017).

 

Total interest income increased by $6.6$16.6 million or 8.1%15.4% to $87.4$124.7 million for the year ended December 31, 20162018, from $80.8$108.1 million for the year ended December 31, 2015. The2017. This is due to solid loan growth, the increase in interest rates and a more profitable earning asset mix. Interest income was duefrom loans increased to the significant$114.4 million for 2018 compared to $99.5 million in 2017, which represents an increase in loan volume.of 14.9%. The average balance of loans receivable increased $166.0$184.3 million to $1.85$2.4 billion at December 31, 20162018, from $1.69$2.2 billion at December 31, 2015. Interest income from loans increased to $80.2 million for 2016 compared to $73.3 million in 2015, which represents an increase of 9.4%.2017.

 

During the same period, the average balance of investment securities decreasedincreased to $233.4$280.0 million for 2016in 2018 from $239.9$258.8 million for the year ended December 31, 2015.2017. Interest income from investment securities decreasedincreased to $6.2$8.1 million in 20162018 compared to $6.8$6.9 million in 2015,2017, which represents a decreasean increase of 7.7%17.1%. The overall duration of investments decreasedincreased to 3.64.29 years at December 31, 20162018, from 4.23.40 years at December 31, 2015.2017.

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Interest expense increased by $1.6$5.0 million in 20162018 compared to 2015,2017, to $8.4$16.5 million from $6.8$11.4 million. This increase was mainly due to an eighta 21 basis point increase in the average cost of interest-bearing liabilities in 20162018 and a $110.2$127.5 million increase in the average balance of interest-bearing liabilities. The average balance of interest bearinginterest-bearing deposits increased $64.3$175.3 million to $1.46$1.95 billion at December 31, 20162018, from $1.40$1.77 billion at December 31, 2015.2017. Interest expense related to interest-bearing deposits was $6.3$13.9 million in 20162018 compared to $5.3$8.8 million in 2015. 2017.

Interest expenses on FHLB advances and other interest-bearing funding sources were $1.3 million and $138,000$23,000 respectively, in 20162018 and $675,000$1.5 million and $152,000$208,000 respectively in 2015.2017. The increasedecrease in FHLB advance expense was due to a $47.7$28.7 million increasedecrease in the average balance of FHLB advances to $85.9$73.4 million at December 31, 20162018, compared to $38.1$102.2 million at December 31, 2015.2017. The decrease in average balances of FHLB advances offset an increase in the rate paid on FHLB advances as it increased to 1.72% at December 31, 2018, from 1.44% at December 31, 2017. Interest expense recognized by the Company related to subordinated debentures was $753,000$1.3 million in 20162018 and $613,000$935,000 in 20152017 due to rising rates.

 

Total interest income increased by $4.6$20.7 million or 6.0%23.7% to $80.8$108.1 million for the year ended December 31, 20152017, from $76.2$87.4 million for the year ended December 31, 2014. The2016. This is primarily due to continued loan growth, the CSB acquisition, the increase in interest income was due to the significant increase in loan volumerates and deploying lower yielding interest bearing deposit balances into higher yielding loans. The average balance of interest bearing deposits decreased to $59.4 million from $134.1 million at December 31, 2014.a more profitable earning asset mix. Interest income from loans increased to $73.3$99.5 million for 20152017 compared to $68.7$80.2 million in 2014,2016, which represents an increase of 6.8%24.1%. The average balance of loans receivable increased $345.2 million to $2.2 billion at December 31, 2017, from $1.9 billion at December 31, 2016, due primarily to the CSB acquisition.

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During the same period, the average balance of investment securities increased to $239.9$258.8 million for 2015in 2017 from $223.5$233.4 million for the year ended December 31, 2014.2016. Interest income from investment securities increased to $6.8$6.9 million in 20152017 compared to $6.6$6.2 million in 2014,2016, which represents an increase of 3.0%11.1%. The overall duration of investments decreasedincreased to 4.23.40 years at December 31, 20152017, from 4.93.38 years at December 31, 2014.2016.

 

Interest expense increased by $222,000$3.0 million in 20152017 compared to 2014,2016, to $6.8$11.4 million from $6.6$8.4 million. This increase was mainly due to a oneseven basis point increase in the average cost of interest-bearing liabilities in 2015.2017 and a $297.3 million increase in the average balance of interest-bearing liabilities. The average balance of interest-bearing deposits increased $305.9 million to $1.77 billion at December 31, 2017, from $1.46 billion at December 31, 2016, primarily due to the CSB acquisition. Interest expense related to interest-bearing deposits was $5.3$8.8 million in 2015 and 2014. Expenses2017 compared to $6.3 million in 2016.

Interest expenses on FHLB advances and other interest-bearing funding sources were $675,000$1.5 million and $152,000$208,000 respectively, in 20152017 and $528,000$1.3 million and $161,000$138,000 respectively in 2014.2016. The increase in FHLB advance expense was primarily due to rising interest rates and a $16.3 million increase in the average balance of FHLB advances to $102.2 million at December 31, 2017, compared to $85.9 million at December 31, 2016. Interest expense recognized by the Company related to subordinated debentures was $613,000$935,000 in 20152017 and $587,000$753,000 in 20142016 due to rising rates.

 

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The following table shows an analysis of net interest margin on a tax equivalent basis for the years ended December 31, 2016, 20152018, 2017 and 2014:2016:

 

Table 3 – Net Interest Margin

 

 Year Ended December 31  Year Ended December 31 
 (In Thousands)     (In Thousands)    
 2016  2015  2014  2018  2017  2016 
 Average
Balance
  Interest
(1)
  Yield/
Rate (2)
  Average
Balance
  Interest
(1)
  Yield/
Rate
  Average
Balance
  Interest
(1)
 

Yield/

Rate

  Average
Balance
  Interest
(1)
  Yield/
Rate (2)
  Average
Balance
  Interest
(1)
  Yield/
Rate
  Average
Balance
  Interest
(1)
  Yield/
Rate
 
      
Interest-Earning Assets:                                                            
Loans receivable (5) $1,853,419 $80,423  4.34% $1,687,413 $73,544  4.36% $1,574,753 $68,828  4.37% $2,382,941  $114,500   4.80% $2,198,639  $99,742   4.54% $1,853,419  $80,423   4.34%
Securities (6)  233,407  7,871  3.48%  239,852  8,476  3.64%  223,534  8,227  3.79%  279,867   9,036   3.23%  258,775   8,654   3.39%  233,407   7,871   3.48%
Interest-earning deposits  67,420  367  0.54%  59,410  169  0.27%  134,114  349  0.26%  63,261   1,270   2.01%  72,215   836   1.16%  67,420   367   0.54%
FHLB stock  13,800  552  4.00%  13,802  552  4.00%  14,677  642  4.37%  15,146   915   6.04%  15,632   784   5.02%  13,800   552   4.00%
Total interest-earning assets  2,168,046  89,213  4.13%  2,000,477  82,741  4.15%  1,947,078  78,046  4.01%  2,741,215   125,721   4.59%  2,545,261   110,016   4.33%  2,168,046   89,213   4.13%
Non-interest-earning assets  229,393          222,389          215,390        
Noninterest-earning assets  307,310           306,270           229,393         
                                                            
Total Assets $2,397,439         $2,222,866         $2,162,468         $3,048,525          $2,851,531          $2,397,439         
                                                            
Interest-Bearing Liabilities:                           Interest-Bearing Liabilities:                               
Interest-bearing deposits $1,463,890  $6,261  0.43% $1,399,619  $5,341  0.38% $1,399,507  $5,283  0.38% $1,945,114  $13,897   0.71% $1,769,786  $8,818   0.50% $1,463,890  $6,261   0.43%
FHLB advances  85,856  1,288  1.50%  38,134  675  1.77%  21,995  528  2.40%  73,421   1,261   1.72%  102,155   1,470   1.44%  85,856   1,288   1.50%
Subordinated debentures  36,141  753  2.09%  36,129  613  1.70%  36,131  587  1.62%  36,083   1,281   3.55%  36,156   935   2.58%  36,141   753   2.09%
Other borrowings  52,826   138   0.26%  54,619   152   0.28%  54,524   161   0.30%  8,947   23   0.26%  27,929   208   0.74%  52,826   138   0.26%
Total interest-bearing liabilities  1,638,713  8,440  0.52%  1,528,501  6,781  0.44%  1,512,157  6,559  0.43%  2,063,565   16,462   0.80%  1,936,026   11,431   0.59%  1,638,713   8,440   0.52%
Non-interest bearing demand deposits  441,731          388,257          350,677        
Total including non-interest- bearing demand deposits  2,080,444  8,440  0.41%  1,916,758  6,781  0.35%  1,862,834  6,559  0.35%
Other non-interest liabilities  31,361          28,463          23,097        
Noninterest-bearing demand deposits  562,439   -       528,926   -       441,731   -     
Total including non- interest- bearing demand deposits  2,626,004   16,462   0.63%  2,464,952   11,431   0.46%  2,080,444   8,440   0.41%
Other noninterest liabilities  38,216           35,343           31,361         
Total Liabilities  2,111,805         1,945,221         1,885,931         2,664,220           2,500,295           2,111,805         
Stockholders’ equity  285,634          277,645          276,537          384,305           351,236           285,634         
Total liabilities and stockholders’ equity $2,397,439         $2,222,866         $2,162,468         $3,048,525          $2,851,531          $2,397,439         
Net interest income; interest rate spread (3)    $80,773   3.61%    $75,960   3.71%    $71,487   3.57%     $109,259   3.79%     $98,585   3.74%     $80,773   3.61%
                                                            
Net interest margin (4)        3.74%        3.81%        3.68%          3.98%          3.88%          3.74%
Average interest-earning assets to average interest- bearing liabilities        132.3%        130.9%        128.8%
Average interest-earning assets to average interest-bearing liabilities          132.8%          131.5%          132.3%

 

(1)Interest on certain tax exempt loans (amounting to $380,000, $375,000 and $383,000 $368,000in 2018, 2017 and $271,000 in 2016, 2015 and 2014 respectively) and tax-exempt securities ($3.03.4 million, $3.2 million and $3.1$3.0 million in 2018, 2017, and 2016, 2015, and 2014)respectively) is not taxable for Federal income tax purposes. The average balance of such loans was $10.5 million, $11.5 million and $11.8 million $10.7 millionin 2018, 2017, and $7.8 million in 2016, 2015, and 2014respectively, while the average balance of such securities was $98.2 million, $91.2 million and $83.4 million $86.0 millionin 2018, 2017, and $82.2 million in 2016, 2015, and 2014, respectively. In order to compare the tax-exempt yields on these assets to taxable yields, the interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 21% for 2018 and 35%. for 2017 and 2016.
(2)At December 31, 2016,2018, the yields earned and rates paid were as follows: loans receivable, 4.20%4.80%; securities, 3.08%3.32%; FHLB stock,4.00%stock, 6.00%; total interest-earning assets, 4.07%4.66%; deposits, 0.26%0.57%; FHLB advances, 1.42%1.88%; other borrowings, 0.22%0.26%, subordinated debentures, 2.39%4.22%; total including non- interest-bearing liabilities, 0.35%0.66%; and interest rate spread, 3.72%3.99%.
(3)Interest rate spread is the difference in the yield on interest-earning assets and the cost of interest-bearing liabilities.
(4)Net interest margin is net interest income divided by average interest-earning assets excluding average unrealized gains/losses. See Non-GAAP Financial Measure discussion for further details.
(5)For the purpose of the computation for loans, nonaccrualnon-accrual loans are included in the average loans outstanding.
(6)Securities yield = annualized interest income divided by the average balance of securities, excluding average unrealized gains/losses.

(6) Securities yield = annualized interest income divided by the average balance of securities, excluding average unrealized gains/losses.

See Non-GAAP Financial Measure discussion for further details.

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The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected First Defiance’s tax-equivalent interest income and interest expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) change in rate (change in rate multiplied by prior year volume), and (iii) total change in rate and volume. The combined effect of changes in both rate and volume has been allocated proportionately to the change due to rate and the change due to volume.

 

Table 4 – Changes in Interest Rates and Volumes (1)

 

 Year Ended December 31  Year Ended December 31 
 (In Thousands)  (In Thousands) 
 2016 vs. 2015  2015 vs. 2014  2018 vs. 2017  2017 vs. 2016 
 Increase
(decrease)
due to
rate
 Increase
(decrease)
due to
volume
 Total
increase
(decrease)
 Increase
(decrease)
due to
rate
 Increase
(decrease)
due to
volume
 Total
increase
(decrease)
  Increase
(decrease)
due to
rate
 Increase
(decrease)
due to
volume
 Total
increase
(decrease)
 Increase
(decrease)
due to
rate
 Increase
(decrease)
due to
volume
 Total increase
(decrease)
 
Interest-Earning Assets                                                
Loans $(326) $7,205  $6,879  $(195) $4,911  $4,716  $6,107  $8,651  $14,758  $3,792  $15,527  $19,319 
Securities  (381)  (224)  (605)  (336)  585   249   (306)  688   382   (66)  849   783 
Interest-earning deposits  173   25   198   30   (210)  (180)  549   (115)  434   441   28   469 
FHLB stock  -   -   -   (53)  (37)  (90)  156   (25)  131   152   80   232 
Total interest-earning assets $(534) $7,006  $6,472  $(554) $5,249  $4,695  $6,506  $9,199  $15,705  $4,319  $16,484  $20,803 
                                                
Interest-Bearing Liabilities                        Interest-Bearing Liabilities                    
Deposits $667  $253  $920  $58  $-  $58  $4,135  $944  $5,079  $1,128  $1,429  $2,557 
FHLB advances  (117)  730   613   (165)  312   147   252   (461)  (209)  (54)  236   182 
Subordinated Debentures  140   -   140   26   -   26   348   (2)  346   182   -   182 
Notes Payable  (9)  (5)  (14)  (9)  -   (9)  (91)  (94)  (185)  159   (89)  70 
Total interest- bearing liabilities $681  $978  $1,659  $(90) $312  $222  $4,644  $387  $5,031  $1,415  $1,576  $2,991 
                        
Increase (decrease) in net interest income         $4,813          $4,473 
Increase in net interest incomeIncrease in net interest income      $10,674          $17,812 

(1)The change in interest rates due to both rate and volume has been allocated between the factors in proportion to the relationship of the absolute dollar amounts of the change in each.

 

Provision for Loan Losses First Defiance’s provision for loan losses was $283,000$1.2 million for the year ended December 31, 20162018, compared to $136,000 for December 31, 2015 and $1.1$2.9 million for December 31, 2014.2017, and $283,000 for December 31, 2016.

 

Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management to absorb probable losses incurred in the loan portfolio. Factors considered by management include identifiable risk in the portfolios, historical experience, the volume and type of lending conducted by First Defiance, the amount of non-performing loans (including loans which meet the FASB ASC Topic 310 definition of impaired), the amount of loans graded by management as substandard, doubtful, or loss, general economic conditions (particularly as they relate to First Defiance’s market areas); and other factors related to the collectability of First Defiance’s loan portfolio. See also Allowance for Loan Losses in this Management’s Discussion and Analysis and Note 7 to the Consolidated Financial Statements.

 

Noninterest IncomeNoninterest income increaseddecreased by $2.2 million$873,000 or 7.0%(2.2%) in 20162018 to $34.0$39.2 million from $31.8$40.1 million for the year ended December 31, 2015.2017. That followed an increase of $162,000$6.1 million or 0.5%17.8% in 20152017 from $31.6$34.0 million in 2014.2016.

 

Service fees and other charges increased to $10.9$13.1 million for the year ended December 31, 20162018, from $10.8$12.1 million for 20152017 and increased from $10.3$10.9 million for 2014.2016. The increase in noninterest incomeservice fees and other charges in 2018 and 2017 from 2016 and 2015 from 2014 is primarily due to new fee structuresincreased number of deposit accounts and product redesigns that were implementedthe CSB acquisition in the third quarter of 2014.2017.

 

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First Federal’s overdraft privilege program generally provides for the automatic payment of modest overdraft limits on all accounts deemed to be in good standing when the account is accessed using paper-based check processing, a teller withdrawal, a point-of-sale terminal, an ACHautomated clearing house (“ACH”) transaction, an online banking or voice-response transfer, or an ATM.automated teller machine (“ATM”). To be in good standing, an account must be brought to a positive balance within a 30-day period and have not excessively used the overdraft privilege program. Overdraft limits are established for all customers without discrimination using a risk assessment approach for each account classification. The approach includes a systematic review and evaluation of the normal deposit flows made to each account classification to establish reasonable and prudent negative balance limits that would be routinely repaid by normal, expected and reoccurring deposits. The risk assessment by portfolio approach assumes a minimal degree of undetermined credit risk associated with unidentified individual accounts that are overdrawn for 30 or more days. Consumer accounts overdrawn for more than 60 days are automatically charged off. Fees are charged as a one-time fee per occurrence, up to five charges per day, and the fee charged for an item that is paid is equal to the fee charged for a non-sufficient fund item that is returned.

 

Overdrawn balances, net of allowance for losses, are reflected as loans on First Defiance’s balance sheet. The fees charged for this service are established based both on the return of processing costs plus a profit, and on the level of fees charged by competitors in the Company’s market area for similar services. These fees are considered to be compensation for providing a service to the customer and therefore deemed to be noninterest income rather than interest income. Fee income recorded for the years ending December 31, 20162018 and 20152017, related to the overdraft privilege product, net of adjustments to the allowance for uncollectible overdrafts, were $2.4 million andboth $2.8 million, respectively. Accounts charged offcharged-off are included in noninterest expense. The allowance for uncollectible overdrafts was $14,000$34,000 at December 31, 20162018, and $18,000$24,000 at December 31, 2015.2017.

 

Noninterest income also includes gains, losses and impairment on investment securities. In 2016,2018, First Defiance realized a $509,000$173,000 gain on sale of securities. In 2015,2017, a $22,000$584,000 gain was recognized compared to a $932,000 net$509,000 gain in 2014.2016.

 

Mortgage banking income includes gains from the sale of mortgage loans, fees for servicing mortgage loans for others, an offset for amortization of mortgage servicing rights, and adjustments for impairment in the value of mortgage servicing rights. Mortgage banking income totaled $7.1 million, $7.0 million and $7.3 million $6.7 millionin 2018, 2017 and $5.6 million in 2016, 2015 and 2014, respectively. The $557,000$73,000 increase in 20162018 from 20152017 is attributable to a $747,000 increase in the gain on saledecrease of loans, along with a $57,000 positive change in servicing revenue. These were partially offset by an increase of $104,000$123,000 in mortgage servicing rights amortization expense along with a $143,000 negative$70,000 increase in servicing revenue and a $42,000 positive change in the valuation adjustments on mortgage servicing rights. This was partially offset by a $162,000 decrease in the gain on sale of loans. First Defiance originated $263.7$205.9 million of residential mortgages for sale into the secondary market in 20162018 compared with $213.4$213.5 million in 2015.2017. The balance of the mortgage servicing right valuation allowance stands at $522,000was $300,000 at the end of 2016. 2018.

The $1.1 million increase$266,000 decrease in 20152017 from 20142016 is attributable to a $1.2 million increase$647,000 decrease in the gain on sale of loans, along with a $150,000 positive$33,000 negative change in the valuation adjustments on mortgage servicing rights. These were partially offset by an increasea decrease of $219,000$260,000 in mortgage servicing rights amortization expense. The positive valuation adjustment isexpense along with a reflection of the$154,000 increase in the fair value of certain sectors of the Company’s portfolio of mortgage servicing rights.revenue. First Defiance originated $213.4$213.5 million of residential mortgages for sale into the secondary market in 20152017 compared with $153.8$263.7 million in 2014.2016. The balance of the mortgage servicing right valuation allowance was $432,000 at the end of 2017. See Note 8 to the Consolidated Financial Statements.

 

Gains on the sale of non-mortgages,non-mortgage loans, which include SBA and FSA loans, totaled $317,000 in 2018 compared to $217,000 in 2017 and $753,000 in 2016 compared to $824,000 in 2015 and $181,000 in 2014.2016. The Company has built up its pipelinevolume of eligible small business administrationSBA loans since 2014decreased in 2018 and increased its selling efforts2017 from levels in 2015 and 2016.

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Insurance commission income increased $365,000$1.2 million or 3.6%9.5% to $10.4$14.1 million in 20162018 from $10.1$12.9 million in 20152017 mainly due to having a full year results of the Corporate One acquisition and an increase in general production in the property and casualty and group employee benefits lines of business. Insurance commission income increased $217,000$2.4 million or 2.2%23.2% to $10.1$12.9 million in 20152017 from $9.9$10.4 million in 2014.2016 mainly due to the acquisition of Corporate One.

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Income from bank owned life insurance increased slightlydecreased $1.3 million in 2018 to $1.8 million from $3.1 million in 2017. In 2017, the Company surrendered an underperforming BOLI policy and recorded a tax penalty of $1.7 million (recorded in income tax expense) and purchased a new BOLI policy receiving a $1.5 million enhancement value gain. The increase to $3.1 million in 2017 from $909,000 in 2016 from $895,000 in 2015, butis also due to the enhancement value gain.

Trust income decreased from $1.8$241,000 to $2.1 million in 2014.2018 from $2.3 million in 2017 and $1.7 million. The decrease in 2015 from 20142018 is the result of a tax-free benefit from a bank-owned life insurance policy due to a death claim$428,000 positive accrual adjustment recorded in 2014.2017 to bring trust fees to an accrual basis of accounting.

 

Other income increased $479,000decreased $1.3 million to $598,000 in 2018 compared to $1.9 million in 2017 and $1.5 million in 2016 compared to $1.12016. The $1.3 million decrease in 2015 and $1.8 million2018 included a $388,000 decrease in 2014. The $479,000 increase in 2016 from 2015 is due to a $231,000 increase in the value of the assets of the Company’s deferred compensation plan as well asassets compared to a $139,000$377,000 increase for the same period in 2017 due to stock market performance in 2018. The $316,000 increase in the gain on sale of other real estate owned. The $708,000 decrease in 2015 from 20142017 is due mainly the result of a $498,000 tax-free gain realized in 2014 through the Company’s deferred compensation plan trust attributable to the aforementioned death claim.group benefit referral fees.

 

Noninterest Expense Total noninterest expense for 20162018 was $71.1$89.4 million compared to $67.9$85.4 million for the year ended December 31, 20152017, and $66.8$71.1 million for the year ended December 31, 2014.2016.

 

Compensation and benefits increased $2.4$2.8 million or 6.4%5.5% to $40.2$52.6 million from $37.8$49.8 million in 2015.2017. The increase is mainly related to merit increases and investing some of the benefits of lower tax rates in support of our metro market growth strategies. Occupancy expense increased $934,000, to $8.6 million in 2018 compared to $7.7 million in 2017 and data processing expense increased $818,000 to $8.6 million in 2018 from $7.7 million in 2017 both increases primarily related to our metro market growth initiatives. Other noninterest expenses decreased $181,000 to $18.6 million in 2018 from $18.8 million in 2017. This decrease is due to an $806,000 benefit from the deferred compensation accounting correction as well as a $1.2 million reduction year over year due to the decline in the liabilities of the deferred compensation plan as a result of the stock market performance in the fourth quarter of 2018. See Note 19 to the Consolidation Financial Statements for further details.

Compensation and benefits increased $9.7 million or 24.0% to $49.8 million from $40.2 million in 2016. The increase is mainly related to personnel expenses both from certain benefit payouts associated with the CSB merger as well as operating the new CSB and Corporate One locations, merit increases and other new staff for growth strategies, higher incentive compensation accruals and higher medical insurance costs.strategies. Other non-interestnoninterest expenses increased $436,000$2.8 million or 2.8%17.5% to $18.8 million in 2017 from $16.0 million in 2016 from $15.52016. This is due mainly to $2.1 million increase in 2015 mainly due to acquisition related costs forexpenses associated with the pending acquisition of Commercial Bancshares, Inc.CSB and $300,000 for a termination of a lease partially offset bya decreaseCorporate One, as well as an increase in the amortization of intangibles of $164,000.$754,000. Occupancy expense increased $221,000,$289,000, to $7.7 million in 2017 compared to $7.4 million in 2016 compared to $7.2 million in 2015 and data processing expense increased $284,000$1.4 million to $7.7 million in 2017 from $6.4 million in 2016 from $6.1 million in 2015. These increases were partially offset by decreases in FDIC insurance premiums of $155,000.

Compensation and benefits increased $2.2 million or 6.3% in 2015 to $37.8 million from $35.5 million in 2014. The increase in compensation and benefits is due to merit increases, staff additions for growth and an increase in incentive compensation as a direct reflection of the improved financial performance of the Company. Occupancy expense increased $514,000 or 7.7% to $7.2 million in 2015, from $6.7 million in 2014. The increase is attributable to projects relating to preventative maintenance and upkeep of the Company’s branch network. Other non-interest expenses decreased $1.7 million or 10.1% to $15.5 million in 2015 from $17.3 million in 2014. The decrease is due to $786,000 of costs in 2014 associated with the termination of First Federal’s merger agreement with First Community Bank.2016.

 

Income Taxes – Income taxes totaled $10.6 million in 2018 compared to $16.2 million in 2017 and $12.8 million in 2016 compared to $11.4 million in 2015 and $9.2 million in 2014.2016. The effective tax rates for those years were 30.7%18.7%, 30.2%33.4%, and 27.4%30.7%, respectively. The tax rate is lower than the statutory 21% and 35% tax rate for the Company mainly because of investments in tax-exempt securities. The increase in the effective tax rate in 2017 primarily relates to the surrender of a bank-owned life insurance policy which added $1.7 million to income tax expense. The earnings on tax-exempt securities are not subject to federal income tax. See Note 18 – Income Taxes in the Notes to the Consolidated Financial Statements for further details.

 

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Concentrations of Credit Risk

 

Financial institutions such as First Defiance generate income primarily through lending and investing activities. The risk of loss from lending and investing activities includes the possibility that losses may occur from the failure of another party to perform according to the terms of the loan or investment agreement. This possibility is known as credit risk.

 

Lending or investing activities that concentrate assets in a way that exposes the Company to a material loss from any single occurrence or group of occurrences increases credit risk. Diversifying loans and investments to prevent concentrations of risks is one way a financial institution can reduce potential losses due to credit risk. Examples of asset concentrations would include multiple loans made to a single borrower and loans of inappropriate size relative to the total capitalization of the institution. Management believes adherence to its loan and investment policies allows it to control its exposure to concentrations of credit risk at acceptable levels. First Defiance’s loan portfolio is concentrated geographically in its northwest and central Ohio, northeast Indiana, central Ohio and southeast Michigan market areas. Management has also identified lending for income-generating rental properties as an industry concentration. Total loans for income- generatingincome-generating rental property totaled $687.5$982.5 million at December 31, 2016,2018, which represents 33.8%37.9% of the Company’s loan portfolio. Management believes it has the skill and experience to manage any risks associated with this type of lending. Loans in this category are generally paying as agreed without any unusual or unexpected levels of delinquency. The delinquency rate in this category, which is any loan 30 days or more past due, was 0.04%0.03% at December 31, 2016.2018. There are no other industry concentrations that exceed 10% of the Company’s loan portfolio.

- 49 -

 

Liquidity and Capital Resources

 

The Company’s primary source of liquidity is its core deposit base, raised through First Federal’s branch network, along with wholesale sources of funding and its capital base. These funds, along with investment securities, provide the ability to meet the needs of depositors while funding new loan demand and existing commitments.

 

Cash generated from operating activities was $53.1 million, $36.0 million and $27.0 million $30.7 millionin 2018, 2017 and $30.1 million in 2016, 2015 and 2014, respectively. The adjustments to reconcile net income to cash provided by or used in operations during the periods presented consist primarily of proceeds from the sale of loans (less the origination of loans held for sale), the provision for loan losses, depreciation expense, the origination, amortization and impairment of mortgage servicing rights and increases and decreases in other assets and liabilities.

 

The primary investing activity of First Defiance is lending, which is funded with cash provided from operating and financing activities, as well as proceeds from payment on existing loans and proceeds from maturities of investment securities. In 20162017 and 2014,2016, the Company purchased $822,000$11.5 million and $16.6 million,$822,000, respectively, in portfolio residential home loans. There were no purchases in 2015.2018.

 

In considering the more typical investing activities, during 2018, $32.6 million and $5.5 million was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $220.0 million was used by an increase in loans while $76.6 million was used to purchase available-for-sale investment securities. During 2017, $32.7 million and $34.2 million was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $133.4 million was used by an increase in loans while $73.0 million was used to purchase available-for-sale investment securities. During 2016, $36.4 million and $14.9 million was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $163.0$158.1 million was used by an increase in loans while $71.3 million was used to purchase available-for-sale investment securities. During 2015, $31.2 million and $426,000 was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $177.0 million was used by an increase in loans while $30.5 million was used to purchase available-for-sale investment securities. During 2014, $20.4 million and $14.9 million was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $73.2 million was used by an increase in loans while $70.1 million was used to purchase available-for-sale investment securities.

- 52 -

 

Principal financing activities include the gathering of deposits, the utilization of FHLB advances, and the sale of securities under agreements to repurchase such securities and borrowings from other banks. In 2018, total deposits increased by $183.2 million. Securities sold under repurchase arrangements decreased by $20.3 million in 2018. Also in 2018, the Company paid $13.0 million in common stock dividends and $6.3 million in common stock purchases. In 2017, total deposits increased by $148.1 million. Securities sold under repurchase arrangements decreased by $5.8 million in 2017. Also in 2017, the Company paid $9.9 million in common stock dividends. In 2016, total deposits increased by $145.5 million. Securities sold under repurchase arrangements decreased by $25.4 million in 2016. Also in 2016, the Company paid $7.9 million in common stock dividends coupled with payingand $6.3 million in common stock repurchases. In 2015, total deposits increased by $75.7 million. Securities sold under repurchase arrangements increased by $2.4 million in 2015. Also in 2015, the Company paid $7.2 million in common stock dividends coupled with paying $8.4 million in common stock repurchases. In 2014, total deposits increased by $25.8 million. Securities sold under repurchase arrangements increased by $2.8 million in 2014. Also in 2014, the Company paid $5.9 million in common stock dividends coupled with paying $15.5 million in common stock repurchases. For additional information about cash flows from First Defiance’s operating, investing and financing activities, see the Consolidated Statements of Cash Flows included in the Consolidated Financial Statements.

 

At December 31, 2016,2018, First Defiance had the following commitments to fund deposit, advance, borrowing obligations and post-retirement benefits:

 

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Table 5 – Contractual Obligations

 

 Maturity Dates by Period at December 31, 2016 
    Less than       After 5  Maturity Dates by Period at December 31, 2018 
Contractual Obligations Total  1 year  1-3 years  4-5 years  years  Total  Less than
1 year
  1-3 years  3-5 years  More than
5 years
 
 (In Thousands)  (In Thousands) 
Certificates of deposit $433,931  $156,767  $196,377  $80,787   -  $680,384  $417,562  $216,319  $46,503   - 
FHLB fixed advances including interest (1)  107,384   32,306   40,490   31,426   3,162   86,747   45,926   36,870   3,388   563 
Subordinated debentures  36,083   -   -   -   36,083   36,083   -   -   -   36,083 
Securities sold under repurchase agreements  31,816   31,816   -   -   -   5,741   5,741   -   -   - 
Lease obligations  4,462   584   737   487   2,654   12,279   967   1,727   1,507   8,078 
Post-retirement benefits  1,927   160   355   377   1,035   1,903   168   376   390   969 
Total contractual obligations $615,603  $221,633  $237,959  $113,077  $42,934  $823,137  $470,364  $255,292  $51,788  $45,693 

(1) Includes principal payments of $103,943 and$85,189, interest payments of $3,441.$1,534 and fair value adj. on acquired balances of $24.

 

At December 31, 2016,2018, First Defiance had the following commitments to fund loan or line of credit obligations:

 

Table 6 - Commitments

 

 Total  Amount of Commitment Expiration by Period 
 Amounts Less than 1       After 5  Total Amount of Commitment Expiration by Period 
Commitments Committed  year  1-3 years  4-5 years  years  Amounts
Committed
 Less than
1 year
 1-3 years 3-5 years More than
5 years
 
 (In Thousands)  (In Thousands) 
Fixed commitments to make loans $34,432  $29,593  $38  $3,892  $909  $44,352  $15,811  $5,228  $8,465  $14,848 
Variable commitments to make loans  106,356   91,788   1,331   277   12,960   114,308   8,876   14,914   31,197   59,321 
Fixed unused lines of credit  14,384   8,638   1,265   82   4,399   7,523   4,150   1,777   1,164   432 
Variable unused lines of credit  400,542   270,099   27,686   5,838   96,919   382,189   162,724   4,349   7,018   208,098 
Total loan commitments  555,714   400,118   30,320   10,089   115,187   548,372   191,561   26,268   47,844   282,699 
                                        
Standby letters of credit  9,668   5,636   4,017   15   -   7,239   7,209   30   -   - 
                                        
Total Commitments $565,382  $405,754  $34,337  $10,104  $115,187  $555,611  $198,770  $26,298  $47,844  $282,699 

 

In addition to the above commitments, at December 31, 2016,2018, First Defiance had commitments to sell $22.5$8.6 million of loans to Freddie Mac, Fannie Mae, or FHLB of Cincinnati or BB&T Mortgage.Cincinnati.

 

To meet its obligations management can adjust the rate of savings certificates to retain deposits in changing interest rate environments; it can sell or securitize mortgage and non-mortgage loans; and it can turn to other sources of financing including FHLB advances, the Federal Reserve, and brokered certificates of deposit. At December 31, 2016,2018, First Defiance had $448.9additional borrowing capacity of $447.4 million in capacity under its agreements with the FHLB.

- 53 -

 

First Federal is subject to various capital requirements of the OCC. At December 31, 2016,2018, First Federal had capital ratios that exceeded the standard to be considered “well capitalized.” For additional information about First Defiance and First Federal’s capital requirements, see Note 17 – Regulatory Matters to the Consolidated Financial Statements.

 

Critical Accounting Policies and Estimates

 

First Defiance has established various accounting policies that govern the application of accounting principles generally accepted in the United States (“GAAP”) in the preparation of its Consolidated Financial Statements. The significant accounting policies of First Defiance are described in the footnotes to the consolidated financial statements.Consolidated Financial Statements. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; Management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying value of assets and liabilities and the results of operations of First Defiance.

 

- 51 -

Allowance for Loan Losses -First Defiance believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of its consolidated financial statements.Consolidated Financial Statements. In determining the appropriate estimate for the allowance for loan losses, management considers a number of factors relative to both specific credits in the loan portfolio and macro-economic factors relative to the economy of the United States as a whole and the economy of the northwest and central Ohio, northeast Indiana and southeast Michigan regions in which the Company does business.

 

Factors relative to specific credits that are considered include a customer’s payment history, a customer’s recent financial performance, an assessment of the value of collateral held, knowledge of the customer’s character, the financial strength and commitment of any guarantors, the existence of any customer or industry concentrations, changes in a customer’s competitive environment and any other issues that may impact a customer’s ability to meet his obligations.

 

Economic factors that are considered include levels of unemployment and inflation, specific plant or business closings in the Company’s market area, the impact of strikes or other work stoppages, the impact of weather or environmental conditions, especially relative to agricultural borrowers, and other matters that may have an impact on the economy as a whole.

 

In addition to the identification of specific customers who may be potential credit problems, management considers its historical losses, the results of independent loan reviews, an assessment of the adherence to underwriting standards, and other factors in providing for loan losses that have not been specifically classified. Management believes that the level of its allowance for loan loss is sufficient to cover the estimates loss incurred but not yet recognized on the loan portfolio. Refer to the section titled “AllowanceAllowance for Loan Losses”Losses in this Management’s Discussion and Analysis and Note 2 - Statement of Accounting Policies for a further description of the Company’s estimation process and methodology related to the allowance for loan losses.

 

Valuation of Mortgage Servicing Rights -First Defiance believes the valuation of mortgage servicing rights is a critical accounting policy that requires significant estimates in preparation of its consolidated financial statements.Consolidated Financial Statements. First Defiance recognizes as separate assets the value of mortgage servicing rights, which are acquired through loan origination activities. First Defiance does not purchase any mortgage servicing rights.

- 54 -

 

Key assumptions made by management relative to the valuation of mortgage servicing rights include the stratification policy used in valuing servicing, assumptions relative to future prepayments of mortgages, the potential value of any escrow deposits maintained or ancillary income received as a result of the servicing activity and discount rates used to value the present value of a future cash flow stream. In assessing the value of the mortgage servicing rights portfolio, management utilizes a third party that specializes in valuing servicing portfolios. That third party reviews key assumptions with management prior to completing the valuation. Prepayment speeds are determined based on projected median prepayment speeds for 15 and 30 year mortgage backed securities. Those speeds are then adjusted up or down based on the size of the loan. The discount rate used in this analysis is the pretax yield generally required by purchasers of bulk servicing rights as of the valuation date. The value of mortgage servicing rights is especially vulnerable in a falling interest rate environment. Refer also to the section entitled Mortgage Servicing Rights in this Management’s Discussion and Analysis and Note 2 - Statement of Accounting Policies and Note 8 - Mortgage Banking to the Consolidated Financial Statements, for a further description of First Defiance’s valuation process, methodology and assumptions along with sensitivity analyses.

 

- 52 -

Goodwill and Intangibles -First Defiance has two reporting units: First Federal and First Insurance. At December 31, 2016,2018, First Defiance had goodwill of $61.8$98.6 million, including $51.0$80.0 million in First Federal, representing 83%81% of total goodwill and $10.8$18.6 million in First Insurance, representing 17%19% of total goodwill. The carrying value of goodwill is tested annually for impairment or more frequently if it is determined appropriate. The evaluation for impairment involves comparing the current estimated fair value of each reporting unit to its carrying value, including goodwill. If the current estimated fair value of a reporting unit exceeds its carrying value, no additional testing is required and impairment loss is not recorded. If the estimated fair value of a reporting unit is less than the carrying value, further valuation procedures are performed and could result in impairment of goodwill being recorded. Further valuation procedures would include allocating the estimated fair value to all assets and liabilities of the reporting unit to determine an implied goodwill value. If the implied value of goodwill of a reporting unit is less than the carrying amount of that goodwill, an impairment loss is recognized in an amount equal to that excess.

 

If, for any future period First Defiance determines that there has been impairment in the carrying value of goodwill balances, First Defiance will record a charge to earnings, which could have a material adverse effect on net income, but not risk-based capital ratios.

 

First Defiance has core deposit and other intangible assets resulting from acquisitions which are subject to amortization. First Defiance determines the amount of identifiable intangible assets based upon independent core deposit and customer relationship analyses at the time of the acquisition. Intangible assets with finite useful lives are evaluated for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. No events or changes in circumstances that would indicate that the carrying amount of any identifiable intangible assets may not be recoverable had occurred during the years ended December 31, 20162018 and 2015.2017.

 

 - 5355 - 

 

 

Item 7A.   Quantitative and Qualitative Disclosures About Market Risk

Item 7A.Quantitative and Qualitative Disclosures About Market Risk

 

Asset/Liability Management

 

A significant portion of the Company’s revenues and net income is derived from net interest income and, accordingly, the Company strives to manage its interest-earning assets and interest-bearing liabilities to generate an appropriate contribution from net interest income. Asset and liability management seeks to control the volatility of the Company’s performance due to changes in interest rates. The Company attempts to achieve an appropriate relationship between rate sensitive assets and rate sensitive liabilities. First Defiance does not presently use off balanceoff-balance sheet derivatives to enhance itsfor risk management.

 

First Defiance monitors interest rate risk on a monthly basis through simulation analysis that measures the impact changes in interest rates can have on net interest income. The simulation technique analyzes the effect of a presumed 100 basis point shift in interest rates (which is consistent with management’s estimate of the range of potential interest rate fluctuations) and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, non-maturity deposit assumptions and capital requirements. At December 31, 2016,2018, the results of the simulation indicate that in an environment where interest rates rise 100 basis points over a 24 month period, First Defiance’s net interest income would increase by 3.08%2.88% over the base case scenario. It should be noted that other areas of First Defiance’s income statement, such as gains from sales of mortgage loans and amortization of mortgage servicing rights are also impacted by fluctuations in interest rates, but are not considered in the simulation of net interest income.

 

The majority of First Federal’s lending activities are in commercial real estate and commercial loan areas. In addition to carrying higher credit risk than residential mortgage lending, such loans tend to be more rate sensitive than residential mortgage loans. The balance of First Federal’s commercial real estate and multi-family real estate loan portfolio was $1.04$1.40 billion, which was split between $142.5$181.7 million of fixed-rate loans and $898.1million$1.22 billion of adjustable-rate loans, at December 31, 2016.2018. The commercial loan portfolio increaseddecreased to $469.1$509.6 million, which was split between $173.1$165.8 million of fixed-rate loans and $296.0$343.8 million of adjustable-rate loans, at December 31, 2016.2018. Certain loans classified as adjustable have fixed rates for an initial term that may be as long as five years. The maturities on fixed-rate loans are generally less than seven years. First Federal also has significant balances$128.2 million of home equity and improvement loans ($118.4 million at December 31, 2016)2018, of which $104.8$116.8 million fluctuate with changes in the prime lending rate and $13.7$11.3 million of home equity and improvement loans have fixed rates. First Federal also has $34.4 million of consumer loans ($16.7 million at December 31, 2016)2018, which tend to have a shorter duration than residential mortgage loans. Also, to limit its interest rate risk, as well as to provide liquidity, First Federal sells a majority of its fixed-rate mortgage originations into the secondary market.

 

The table below presents, for the twelve months subsequent to December 31, 20162018, and December 31, 2015,2017, an estimate of the change in net interest income that would result from a gradual (ramp) and immediate (shock) change in interest rates, moving in a parallel fashion over the entire yield curve, relative to the measured base case scenario. Based on our net interest income simulation as of December 31, 2016,2018, net interest income sensitivity to changes in interest rates for the twelve months subsequent to December 31, 20162018, was more assetslightly less liability sensitive for the ramp and shock compared to the sensitivity profile for the twelve months subsequent to December 31, 2015. This is due2017. The Company did not complete an earnings at risk analysis for the down 200 basis point change in partrates as of December 31, 2017. Management noted the likelihood of a decrease beyond 100 basis points as of December 31, 2017, was considered to our strategy to grow longer term loansbe unlikely given the interest rate levels at that time and funding that growth out of existing liquidity.therefore was not included in this analysis.

 

 - 5456 - 

 

 

Table 7 – Net Interest Income Sensitivity Profile

 

 Impact on Future Annual Net Interest Income  Impact on Future Annual Net Interest Income 
(dollars in thousands) December 31, 2016  December 31, 2015  December 31, 2018  December 31, 2017 
Gradual Change in Interest Rates                                
+200 $1,970   2.32% $563   0.71% $1,910   1.61% $2,354   2.18%
+100  972   1.14%  215   0.27%  981   0.83%  1,200   1.11%
-100  (2,201)  -2.59%  (1,332)  -1.68%  (2,025)  -1.71%  (3,033)  -2.81%
                
-200  (6,236)  -5.27%  -   - 
Immediate Change in Interest Rates                                
+200 $4,236   4.99% $1,660   2.09% $3,424   2.89% $4,821   4.47%
+100  2,131   2.51%  719   0.91%  1,865   1.57%  2,463   2.28%
-100  (4,132)  -4.87%  (2,605)  -3.28%  (5,057)  -4.27%  (6,223)  -5.77%
-200  (14,455)  -12.21%  -   - 

 

To analyze the impact of changes in interest rates in a more realistic manner, non-parallel interest rate scenarios are also simulated. These non-parallel interest rate scenarios indicate that net interest income may decrease from the base case scenario should the yield curve flatten.flatten or become inverted. Conversely, if the yield curve should steepen, or become inverted, net interest income may increase.

 

The results of all the simulation scenarios are within the boardBoard mandated guidelines as of December 31, 2016.2018, except for the down 200 basis points over the first twelve months in a static and dynamic-shock balance sheet as well as in the down 200 basis points for a cumulative twenty-four months in a Static and dynamic ramp balance sheet. Management is reviewing the Board policy limits in all scenarios to determine if they are adequate and if so, any measures to be taken to bring the current results back into alignment with Board mandated guidelines.

 

In addition to the simulation analysis, First Federal also prepares an “economic value of equity” (“EVE”) analysis. This analysis generally calculates the net present value of First Federal’s assets and liabilities in rate shock environments that range from –400 basis points to +400 basis points. However, the likelihood of a decrease in interest rates beyond 100200 basis points as of December 31, 20162018, was considered to be unlikely given the current interest rate levels and therefore was not included in this analysis. The results of this analysis are reflected in the following table.

 

Table 8 – Economic Value of Equity Analysis

 

December 31, 2016
December 31, 2018December 31, 2018 
        Economic Value of Equity as % of         Economic Value of Equity as % of 
 Economic Value of Equity  Present Value of Assets  Economic Value of Equity  Present Value of Assets 
Change in Rates $ Amount  $ Change  % Change  Ratio  Change  $ Amount  $ Change  % Change  Ratio  Change 
(Dollars in Thousands)
+ 400 bp  569,397   85,791   17.74%  24.99%  522  bp   751,259   66,752   9.75%  25.96%  404  bp 
+ 300 bp  553,285   69,679   14.41%  23.86%  408  bp   741,404   56,897   8.31%  25.13%  322  bp 
+ 200 bp  534,478   50,873   10.52%  22.63%  286  bp   729,505   44,998   6.57%  24.25%  233  bp 
+ 100 bp  512,132   28,526   5.90%  21.30%  153  bp   710,688   26,181   3.82%  23.18%  126  bp 
0 bp  483,606   -   -   19.77%     684,507   -   -   21.92%   
- 100 bp  429,266   (34,339)  (7.10)%  17.29%  (249) bp   642,625   (41,882)  (6.12)%  20.26%  (165) bp 
- 200 bp  578,124   (106,383)  (15.54)%  18.04%  (387) bp 

 

December 31, 2015
           Economic Value of Equity as % of 
  Economic Value of Equity  Present Value of Assets 
Change in Rates $ Amount  $ Change  % Change  Ratio  Change 
(Dollars in Thousands)
+ 400 bp  509,640   56,545   12.48%  24.08%  422  bp 
+ 300 bp  499,038   45,943   10.14%  23.15%  329  bp 
+ 200 bp  486,652   33,558   7.41%  22.15%  229  bp 
+ 100 bp  471,332   18,237   4.03%  21.05%  119  bp 
        0 bp  453,095   -   -   19.86%   
- 100 bp  426,010   (27,085)  (5.98)%  18.39%  (147) bp 

 - 5557 - 

 

December 31, 2017 
           Economic Value of Equity as % of 
  Economic Value of Equity  Present Value of Assets 
Change in Rates $ Amount  $ Change  % Change  Ratio  Change 
(Dollars in Thousands)
+ 400 bp  700,563   80,544   12.99%  25.63%  462  bp 
+ 300 bp  685,883   65,864   10.62%  24.63%  362  bp 
+ 200 bp  668,127   48,108   7.76%  23.53%  252  bp 
+ 100 bp  647,439   27,420   4.42%  22.36%  135  bp 
0 bp  620,019   -   -   21.01%   
- 100 bp  585,967   (34,052)  (5.49)%  19.52%  (149) bp 

 

Based on the above analysis, in the event of a 200 basis point increase in interest rates as of December 31, 2016,2018, First Federal would experience a 10.52%6.57% increase in its economic value of equity. During periods of rising rates, the value of monetary assets declines. Conversely, during periods of falling rates, the value of monetary assets increases. It should be noted that the amount of change in value of specific assets and liabilities due to changes in rates is not the same in a rising rate environment as in a falling rate environment. Based on the EVE analysis, the change in the economic value of equity in both rising and falling rate environments is relatively low because both its assets and liabilities have relatively short durations. The average duration of its assets at December 31, 20162018, was 1.701.75 years while the average duration of its liabilities was 3.633.52 years.

 

In evaluating First Federal’s exposure to interest rate risk, certain shortcomings inherent in each of the methods of analysis presented must be considered. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates while interest rates on other types of financial instruments may lag behind current changes in market rates. Furthermore, in the event of changes in rates, prepayments and early withdrawal levels could differ significantly from the assumptions in calculating the table and the results therefore may differ from those presented.

 

 - 5658 - 

 

 

Item 8.   Financial Statements and Supplementary Data

Item 8.Financial Statements and Supplementary Data

 

Management’s Report on Internal Control Over Financial Reporting

 

The management of First Defiance Financial Corp. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(1)13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of;of our principal executive and principal financial officers and effected by the boardBoard of directors,Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that:

 

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

1.Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

 

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

2.Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

3.Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.

 

Based on our evaluation under the framework in the 2013 Internal Control – Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2016.2018.

 

Crowe Horwath LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued a report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016.2018. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016,2018, is herein.included in this Item 8.

 

  
Donald P. HilemanKevin T. Thompson
President andExecutive Vice President and
Chief Executive OfficerChief Financial Officer

 

 - 5759 - 

 

 

Report of Independent Registered Public Accounting Firm

 

MembersStockholders and the Board of the Audit CommitteeDirectors of

First Defiance Financial Corp.

Defiance, Ohio

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the accompanying consolidated statements of financial condition of First Defiance Financial Corp. (the “Company”) as of December 31, 20162018 and 2015 and2017, the related consolidated statements of income, comprehensive income, changes in stockholders'stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016.2018, and the related notes (collectively referred to as the “financial statements”). We also have audited First Defiance Financial Corp.’sthe Company’s internal control over financial reporting as of December 31, 2016,2018, based on criteria established in the 2013 Internal Control – Integrated FrameworkFramework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO”(“COSO”).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

Basis for Opinions

The Company'sCompany’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on thesethe Company’s financial statements and an opinion on the Company'sCompany’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supportingregarding the amounts and disclosures in the financial statements, assessingstatements. Our audits also included evaluating the accounting principles used and significant estimates made by management, andas well as evaluating the overall presentation of the financial statement presentation.statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

- 60 -

Definition and Limitations of Internal Control Over Financial Reporting

A company'scompany’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company'scompany’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company'scompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

- 58 -

In our opinion,We have served as the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Defiance Financial Corp. as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016 in conformity withCompany’s independent registered public accounting principles generally accepted in the United States of America. Also in our opinion, First Defiance Financial Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the COSO.firm since 2005.

 

/s/ Crowe Horwath LLP 
Crowe Horwath LLP 
South Bend, Indiana 
February 28, 20172019 

 

 - 5961 - 

 

 

First Defiance Financial Corp.

Consolidated Statements of Financial Condition

Dollars in Thousands, except per share data

First Defiance Financial Corp.First Defiance Financial Corp.
Consolidated Statements of Financial ConditionConsolidated Statements of Financial Condition
(Dollars in Thousands, except per share data)(Dollars in Thousands, except per share data)
     
 December 31  December 31 
 2016  2015  2018  2017 
Assets                
Cash and cash equivalents:                
Cash and amounts due from depository institutions $53,003  $38,769  $55,962  $58,693 
Federal funds sold  46,000   41,000   43,000   55,000 
  99,003   79,769   98,962   113,693 
 ��              
Securities available-for-sale, carried at fair value  250,992   236,435   294,076   260,650 
Securities held-to-maturity, carried at amortized cost (fair value $187 and $245 at December 31, 2016 and 2015 respectively)  184   243 
Securities held-to-maturity, carried at amortized cost (fair value $526 and $649 at December 31, 2018 and 2017, respectively)  526   648 
  251,176   236,678   294,602   261,298 
Loans held for sale  9,607   5,523   6,613   10,435 
Loans receivable, net of allowance of $25,884 and $25,382 at December 31, 2016 and 2015, respectively 1,914,603  1,776,835 
        
Loans receivable, net of allowance of $28,331 and $26,683 at December 31, 2018 and 2017, respectively  2,511,708   2,322,030 
Mortgage servicing rights  9,595   9,248   10,119   9,808 
Accrued interest receivable  6,760   6,171   9,641   8,706 
Federal Home Loan Bank (FHLB) stock  13,798   13,801   14,217   15,992 
Bank owned life insurance  52,817   51,908   67,660   66,230 
Premises and equipment  36,958   38,166   40,670   40,217 
Real estate and other assets held for sale (REO)  455   1,321 
Real estate and other assets held for sale (OREO)  1,205   1,532 
Goodwill  61,798   61,798   98,569   98,569 
Core deposit and other intangibles  1,336   1,871   4,391   5,703 
Deferred taxes  2,212   -   -   231 
Other assets  17,479   14,587   23,365   38,959 
Total assets $2,477,597  $2,297,676  $3,181,722  $2,993,403 

 

continued

 - 6062 - 

 

 

First Defiance Financial Corp
Consolidated Statements of Financial Condition (continued)
(Dollars in Thousands, except per share data)
    
  December 31 
  2018  2017 
Liabilities and stockholders’ equity        
Liabilities:        
Deposits:        
Noninterest-bearing $607,198  $571,360 
Interest-bearing  2,013,684   1,866,296 
Total  2,620,882   2,437,656 
Advances from the Federal Home Loan Bank  85,189   84,279 
Securities sold under agreements to repurchase  5,741   26,019 
Subordinated debentures  36,083   36,083 
Advance payments by borrowers  3,652   2,925 
Deferred taxes  264   - 
Other liabilities  30,322   33,155 
Total liabilities  2,782,133   2,620,117 
         
Commitments and Contingent Liabilities (Note 6)        
         
Stockholders’ equity:        
Preferred stock, $.01 par value per share: 37,000 shares authorized; no shares issued      
Preferred stock, $.01 par value per share:        
4,963,000 shares authorized; no shares issued      
Common stock, $.01 par value per share:        
50,000,000 shares authorized; 25,398,992 and 25,425,682 shares issued and 20,171,392 and 20,312,082 shares outstanding, respectively(1)  127   127 
Additional paid-in capital  161,593   160,940 
Accumulated other comprehensive income, net of tax of $(468) and $117, respectively  (2,148)  217 
Retained earnings  295,588   262,900 
Treasury stock, at cost, 5,227,600 and 5,113,600 shares respectively(1)  (55,571)  (50,898)
Total stockholders’ equity  399,589   373,286 
         
Total liabilities and stockholders’ equity $3,181,722  $2,993,403 

 

First Defiance Financial Corp

Consolidated Statements of Financial Condition (continued)

Dollars in Thousands, except per share data

  December 31 
  2016  2015 
Liabilities and stockholders’ equity        
Liabilities:        
Deposits:        
Noninterest-bearing $487,663  $420,691 
Interest-bearing  1,493,965   1,415,446 
Total  1,981,628   1,836,137 
Advances from the Federal Home Loan Bank  103,943   59,902 
Securities sold under agreements to repurchase  31,816   57,188 
Subordinated debentures  36,083   36,083 
Advance payments by borrowers  2,650   2,674 
Deferred taxes  -   877 
Other liabilities  28,459   24,618 
Total liabilities  2,184,579   2,017,479 
         
Commitments and Contingent Liabilities (Note 6)        
         
Stockholders’ equity:        
Preferred stock, $.01 par value per share: 37,000 shares authorized; no shares issued      
Preferred stock, $.01 par value per share: 4,963,000 shares authorized; no shares issued      
Common stock, $.01 par value per share: 25,000,000 shares authorized; 12,720,347 and 12,721,959 shares issued and 8,983,206 and 9,102,831 shares outstanding, respectively  127   127 
Additional paid-in capital  126,390   125,734 
Accumulated other comprehensive income, net of tax of $117 and $1,950, respectively  215   3,622 
Retained earnings  240,592   219,737 
Treasury stock, at cost, 3,737,141 and 3,619,128   shares respectively  (74,306)  (69,023)
Total stockholders’ equity  293,018   280,197 
         
Total liabilities and stockholders’ equity $2,477,597  $2,297,676 
(1)Share data has been adjusted to reflect a 2-for-1 stock split on July 12, 2018.

 

See accompanying notes.notes

 

 - 6163 - 

 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Income

(Dollar Amounts in Thousands, except per share data)

  Years Ended December 31 
  2018  2017  2016 
Interest Income            
Loans $114,398  $99,540  $80,217 
Investment securities:            
Taxable  4,738   3,762   3,231 
Tax-exempt  3,396   3,180   3,016 
Interest-bearing deposits  1,270   836   367 
FHLB stock dividends  915   784   552 
Total interest income  124,717   108,102   87,383 
             
Interest Expense            
Deposits  13,897   8,818   6,261 
Federal Home Loan Bank advances and other  1,261   1,470   1,288 
Subordinated debentures  1,281   935   753 
Securities sold under agreement to repurchase  23   208   138 
Total interest expense  16,462   11,431   8,440 
Net interest income  108,255   96,671   78,943 
             
Provision for loan losses  1,176   2,949   283 
Net interest income after provision for loan losses  107,079   93,722   78,660 
             
Noninterest Income            
Service fees and other charges  13,100   12,139   10,909 
Mortgage banking income  7,077   7,004   7,270 
Insurance commissions  14,085   12,866   10,441 
Gain on sale of non-mortgage loans  317   217   753 
Gain  on sale or call of securities  173   584   509 
Trust income  2,091   2,332   1,701 
Income from bank owned life insurance  1,767   3,085   909 
Other noninterest income  598   1,854   1,538 
Total noninterest income  39,208   40,081   34,030 
             
Noninterest Expense            
Compensation and benefits  52,566   49,847   40,187 
Occupancy  8,641   7,707   7,418 
FDIC insurance  1,021   1,250   1,169 
Data processing  8,555   7,737   6,367 
Other noninterest expense  18,629   18,810   15,952 
Total noninterest expense  89,412   85,351   71,093 
             
Income before income taxes  56,875   48,452   41,597 
Federal income taxes  10,626   16,184   12,754 
Net Income $46,249  $32,268  $28,843 
             
Earnings per common share (Note 4)            
Basic $2.27  $1.62  $1.61 
Diluted $2.26  $1.61  $1.60 
Dividends declared per common share $0.64  $0.50  $0.44 

 

  Years Ended December 31 
  2016  2015  2014 
Interest Income            
Loans $80,217  $73,346  $68,682 
Investment securities:            
Taxable  3,231   3,598   3,507 
Tax-exempt  3,016   3,171   3,068 
Interest-bearing deposits  367   169   349 
FHLB stock dividends  552   552   642 
Total interest income  87,383   80,836   76,248 
             
Interest Expense            
Deposits  6,261   5,341   5,283 
Federal Home Loan Bank advances and other  1,288   675   528 
Subordinated debentures  753   613   587 
Securities sold under agreement to repurchase  138   152   161 
Total interest expense  8,440   6,781   6,559 
Net interest income  78,943   74,055   69,689 
             
Provision for loan losses  283   136   1,117 
Net interest income after provision for loan losses  78,660   73,919   68,572 
             
Noninterest Income            
Service fees and other charges  10,909   10,752   10,258 
Mortgage banking income  7,270   6,713   5,602 
Insurance commissions  10,441   10,076   9,859 
Gain on sale of non-mortgage loans  753   824   181 
Gain (loss) on sale or call of securities  509   22   932 
Trust income  1,701   1,462   1,240 
Income from bank owned life insurance  909   895   1,802 
Other noninterest income (Note 15)  1,538   1,059   1,767 
Total noninterest income  34,030   31,803   31,641 
             
Noninterest Expense            
Compensation and benefits  40,187   37,769   35,543 
Occupancy  7,418   7,197   6,683 
FDIC insurance  1,169   1,324   1,419 
Data processing  6,367   6,083   5,856 
Other noninterest expense  15,952   15,516   17,257 
Total noninterest expense  71,093   67,889   66,758 
             
Income before income taxes  41,597   37,833   33,455 
Federal income taxes  12,754   11,410   9,163 
Net Income $28,843  $26,423  $24,292 
             
Earnings per common share (Note 4)            
Basic $3.21  $2.87  $2.55 
Diluted $3.19  $2.82  $2.44 
Dividends declared per common share $0.880  $0.775  $0.625 

See accompanying notes

 

 - 6264 - 

 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)

 

 For the Years Ended December 31  For the Years Ended December 31 
 2016  2015  2014  2018  2017  2016 
              
Net income $28,843  $26,423  $24,292  $46,249  $32,268  $28,843 
Change in securities available-for-sale (AFS):                        
Unrealized holding gains (losses) on available-for-sale securities arising during the period  (4,933)  (985)  6,763   (3,356)  732   (4,933)
Reclassification adjustment for (gains) losses realized in income  (509)  (22)  (932)  (173)  (584)  (509)
Net unrealized gains (losses)  (5,442)  (1,007)  5,831   (3,529)  148   (5,442)
                        
Income tax effect  1,904   352   (2,040)  742   (51)  1,904 
Net of tax amount  (3,538)  (655)  3,791   (2,787)  97   (3,538)
                        
Change in unrealized gain/(loss) on postretirement benefit:                        
Net gain (loss) on defined benefit postretirement medical plan realized during the period  172   204   (377)  560   (166)  172 
Net amortization and deferral  30   47   35   18   20   30 
Net gain (loss) activity during the period  202   251   (342)  578   (146)  202 
Income tax effect  (71)  (88)  120   (203)  51   (71)
Net of tax amount  131   163   (222)  375   (95)  131 
                        
Total other comprehensive income (loss)  (3,407)  (492)  3,569   (2,412)  2   (3,407)
Comprehensive income $25,436  $25,931  $27,861  $43,837  $32,270  $25,436 
            

 

See accompanying notes

 

 - 6365 - 

 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Changes in Stockholders’ Equity

(Dollar Amounts In Thousands, except number of shares)

 

           Accumulated                   Accumulated        
   Common   Common Additional Other     Total     Common     Common Additional Other       Total 
 Preferred Stock Common Stock Paid-In Comprehensive Retained Treasury Stockholder’s  Preferred Stock Common Stock Paid-In Comprehensive Retained Treasury Stockholder’s 
 Stock Shares Stock Warrant Capital Income Earnings Stock Equity  Stock  Shares(1)  Stock  Warrant  Capital  Income (Loss)  Earnings  Stock  Equity 
Balance at January 1, 2014 $-   9,719,521  $127  $878  $136,403  $545  $182,290  $(48,096) $272,147 
Net income                          24,292       24,292 
Other comprehensive income                      3,569           3,569 
Stock based compensation expenses                  78               78 
Shares issued under stock option plan      52,258           88       (45)  878   921 
Restricted share activity under stock incentive plans      13,087           (334)          212   (122)
Shares issued from direct stock sales      2,804           31           45   76 
Shares repurchased      (553,136)                      (15,519)  (15,519)
Common stock dividends declared                   ��      (5,937)      (5,937)
Balance at December 31, 2014 $-   9,234,534  $127  $878  $136,266  $4,114  $200,600  $(62,480) $279,505 
Balance at January 1, 2016 $-   18,205,662  $127  $-  $125,734  $3,622  $219,737  $(69,023) $280,197 
Net income                          26,423       26,423                           28,843       28,843 
Other comprehensive loss                      (492)          (492)                      (3,407)          (3,407)
Stock based compensation expenses                  150               150                   274               274 
Warrant repurchase              (878)  (11,101)              (11,979)
Shares issued under stock option plan,      74,300                             
net of 14,350 repurchased and retired                  230       (313)  1,552   1,469 
Restricted share activity under stock incentive plans      18,006           (58)      186   308   436 
Excess tax benefit on stock compensation plans                  216               216 
Shares issued from direct stock sales      1,799           31           33   64 
Shares repurchased      (225,808)                      (8,436)  (8,436)
Common stock dividends declared                          (7,159)      (7,159)
Balance at December 31, 2015 $-   9,102,831  $127  $-  $125,734  $3,622  $219,737  $(69,023) $280,197 
Net income                          28,843       28,843 
Other comprehensive loss                      (3,407)          (3,407)
Stock based compensation expenses                  274               274 
Shares issued under stock option plan,                                    
net of 1,612 repurchased and retired      36,358           (21)      (26)  761   714 
Shares issued under stock option plan,
net of 3,224 repurchased and retired
      72,716           (21)      (26)  761   714 
Restricted share activity under stock incentive plans      10,405           370       (72)  219   517       20,810           370       (72)  219   517 
Shares issued from direct stock sales      1,480           33           30   63       2,960           33           30   63 
Shares repurchased      (167,868)                      (6,293)  (6,293)      (335,736)                      (6,293)  (6,293)
Common stock dividends declared                          (7,890)      (7,890)                          (7,890)      (7,890)
Balance at December 31, 2016 $-   8,983,206  $127  $-  $126,390  $215  $240,592  $(74,306) $293,018  $-   17,966,412  $127  $-  $126,390  $215  $240,592  $(74,306) $293,018 
Net income                          32,268       32,268 
Other comprehensive income                      2           2 
Stock based compensation expenses                  215               215 
Shares issued under stock option plan,
net of 15,014 repurchased and retired
      8,088           51       (83)  231   199 
Capital stock issuance      2,279,004           33,792           22,740   56,532 
Restricted share activity under stock incentive plans      55,754           447       (18)  409   838 
Shares issued from direct stock sales      2,824           45           28   73 
Common stock dividends declared                          (9,859)      (9,859)
Balance at December 31, 2017 $-   20,312,082  $127  $-  $160,940  $217  $262,900  $(50,898) $373,286 
Net income                          46,249       46,249 
Other comprehensive loss                      (2,412)          (2,412)
Adoption of ASU 2018-02 – See Note 2                      47   (47)      - 
Deferred compensation plan                              636   636 
Stock based compensation expenses                  420               420 
Shares issued under stock option plan,
net of 8,872 repurchased and retired
      38,628           (93)      (270)  474   111 
Restricted share activity under stock incentive
plans net of 17,818 repurchased and retired
      48,300           258       (201)  511   568 
Shares issued from direct stock sales      3,542           68           36   104 
Shares repurchased      (231,160)                      (6,330)  (6,330)
Common stock dividends declared                          (13,043)      (13,043)
Balance at December 31, 2018 $-   20,171,392  $127  $-  $161,593  $(2,148) $295,588  $(55,571) $399,589 

 

See accompanying notes

 

 - 6466 - 

 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)

 

 Years Ended December 31  Years Ended December 31 
 2016  2015  2014  2018  2017  2016 
Operating Activities                        
Net income $28,843  $26,423  $24,292  $46,249  $32,268  $28,843 
Adjustments to reconcile net income to net cash provided by operating activities:                        
Provision for loan losses  283   136   1,117   1,176   2,949   283 
Provision for depreciation  3,356   3,267   2,952   3,688   3,567   3,356 
Net amortization of premium and discounts on loans, securities, deposits and debt obligations  1,128   1,148   1,020 
Net amortization of premium and discounts on loans,            
securities, deposits and debt obligations  861   740   1,128 
Amortization of mortgage servicing rights  1,724   1,620   1,401   1,341   1,464   1,724 
Net impairment (recovery) of mortgage servicing rights  (123)  (266)  (116)
Net recovery of mortgage servicing rights  (132)  (89)  (123)
Amortization of intangibles  535   699   1,102   1,312   1,289   535 
Gain on sale of loans  (6,064)  (5,388)  (3,517)  (4,819)  (4,881)  (6,064)
Loss on sale or disposals or write-downs of property, plant and equipment  -   428   -   13   48   - 
(Gain) loss on sale or write-down of REO  (300)  150   (73)
(Gain) loss on sale or call of securities  (509)  (22)  (932)
(Gain) loss on sale or write-down of OREO  581   (56)  (300)
Gain on sale or call of securities  (173)  (584)  (509)
Change in deferred taxes  (615)  (35)  (179)  881   1,261   (615)
Proceeds from sale of loans held for sale  262,958   215,402   159,305   212,688   215,727   262,958 
Origination of loans held for sale  (263,679)  (213,416)  (153,753)  (205,884)  (213,479)  (263,679)
Stock based compensation expenses  274   150   78   420   215   274 
Restricted stock unit expense (credit)  517   436   (122)
Excess tax benefit (expense)on stock compensation plans  (192)  216   - 
Restricted stock unit expense  568   838   517 
Excess tax benefit (expense) on stock compensation plans  (154)  (171)  (192)
Income from bank owned life insurance  (909)  (895)  (1,802)  (1,767)  (3,085)  (909)
Change in interest receivable and other assets  (4,121)  (1,356)  (5,962)  (2,878)  (3,591)  (4,121)
Change in accrued interest and other liabilities  3,878   1,955   5,254   (916)  1,527   3,878 
Net cash provided by operating activities  26,984   30,652   30,065   53,055   35,957   26,984 
                        
Investing Activities                        
Proceeds from maturities, calls and paydowns of held-to-maturity securities  59   69   73   122   128   59 
Proceeds from maturities, calls and paydowns of available-for-sale securities  36,390   31,240   20,400   32,620   32,687   36,390 
Proceeds from sale of available-for-sale securities  14,871   426   14,913   5,503   34,248   14,871 
Proceeds from sale of REO  1,705   3,407   2,108 
Proceeds from sale of OREO  887   554   1,705 
Proceeds from sale of office properties and equipment  1   212   84   14   849   1 
Purchases of available-for-sale securities  (71,276)  (30,483)  (70,149)  (76,647)  (73,007)  (71,276)
Purchases of office properties and equipment  (2,106)  (1,843)  (4,935)  (4,168)  (3,263)  (2,106)
Investment in bank owned life insurance  -   (4,000)  (3,406)  -   (20,000)  - 
Proceeds from bank owned life insurance death benefit  337   -   - 
Proceeds from sale of bank owned life insurance  17,689   -   - 
Proceeds from FHLB stock redemption  3   1   5,548   1,775   -   3 
Proceeds from bank owned life insurance death benefit  -   -   910 
Net cash paid in Buckeye Insurance acquisition  -   (297)  - 
Net cash received (paid) in acquisitions  -   19,359   - 
Purchase of portfolio mortgage loans  (822)  -   (16,594)  -   (11,476)  (822)
Proceeds from sale of non-mortgage loans  20,816   24,027   20,592   28,729   20,227   20,816 
Net increase in loans receivable  (158,121)  (177,013)  (73,206)  (219,885)  (133,184)  (158,121)
Net cash used in investing activities  (158,480)  (154,254)  (103,662)  (213,024)  (132,878)  (158,480)

Continued

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FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Cash Flows (continued)

(Dollar Amounts in Thousands)

 

 Years Ended December 31  Years Ended December 31 
 2016  2015  2014  2018  2017  2016 
Financing Activities                        
Net increase in deposits and advance payments by borrowers  145,467   75,689   25,810   183,764   148,065   145,467 
Repayment of Federal Home Loan Bank long-term advances  (959)  (8,642)  (976)
Proceeds from Federal Home Loan Bank long-term advances  45,000   47,000   - 
Increase (decrease) in securities sold under repurchase agreements  (25,372)  2,429   2,840 
Repayment of Federal Home Loan Bank advances  (34,090)  (31,070)  (959)
Proceeds from Federal Home Loan Bank advances  35,000   10,000   45,000 
Decrease in securities sold under repurchase agreements  (20,278)  (5,797)  (25,372)
Cash dividends paid on common stock  (7,890)  (7,159)  (5,937)  (13,043)  (9,859)  (7,890)
Net cash paid for repurchase of common stock  (6,293)  (8,436)  (15,519)  (6,330)  -   (6,293)
Repayment of warrants  -   (11,979)  - 
Proceeds from exercise of stock options  714   1,469   921   111   199   714 
Proceeds from direct treasury stock sales  63   64   76 �� 104   73   63 
Net cash provided by financing activities  150,730   90,435   7,215   145,238   111,611   150,730 
                        
Increase (decrease) in cash and cash equivalents  19,234   (33,167)  (66,382)  (14,731)  14,690   19,234 
Cash and cash equivalents at beginning of period  79,769   112,936   179,318   113,693   99,003   79,769 
Cash and cash equivalents at end of period $99,003  $79,769  $112,936  $98,962  $113,693  $99,003 
                        
Supplemental cash flow information:                        
Interest paid $8,370  $6,764  $6,557  $16,198  $11,382  $8,370 
Income taxes paid  12,700   10,000   8,950   7,950   14,350   12,700 
Transfer from other liability to equity  636   -   - 
            
Transfers from loans to other real estate owned and other assets held for sale  583   974   2,357   1,141   705   583 
Transfer from real estate owned and other assets held for sale to loans  -   2,544   - 
Transfer from (to) property and equipment to real estate and other assets held for sale  (44)  267   -   -   (130)  (44)
Transfer from loans held for sale to loans  -   -   1,178 
Sale of bank owned life insurance not yet settled  -   17,840   - 
Securities traded but not yet settled  357   -   -   -   548   357 

 

See accompanying notes.

 

 - 6668 - 

 

Notes to the Consolidated Financial Statements

 

1. Basis of Presentation

 

First Defiance Financial Corp. (“First Defiance” or the “Company”) is a unitary thrift holding company that conducts business through its three wholly owned subsidiaries, First Federal Bank of the Midwest (“First Federal”), First Insurance Group of the Midwest, Inc. (“First Insurance”), and First Defiance Risk Management, Inc. (“First Defiance Risk Management”). All significant intercompany transactions and balances are eliminated in consolidation.

 

First Federal is primarily engaged in attracting deposits from the general public through its officesbranches and using those and other available sources of funds to originate loans primarily in the counties in which its offices are located. First Federal’s traditional banking activities include originating and servicing residential, commercial and consumer loans and providing a broad range of depository, trust and wealth management services.

First Insurance is an insurance agency that doesconducts business in the Defiance, Bryan, Bowling Green, Lima, Maumee and Oregon, Ohio areas,(throughout First Federal’s Market) offering property and casualty, and group health and life insurance products.

First Defiance Risk Management was incorporated on December 20, 2012, as a wholly owned insurance company subsidiary of the Company to insure the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace.

On June 22, 2018, the Company announced a stock split in the form of a share distribution of two common shares for each outstanding common share. The stock split was distributed on July 12, 2018, to shareholders of record as of July 2, 2018. All share and per share data in this Form 10-K have been adjusted and are reflective of the stock split.

 

2. Statement of Accounting Policies

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

 

Earnings Per Common Share

 

Basic earnings per common share is computed by dividing net income applicable to common shares (net income less dividend requirements for preferred stock, accretion of preferred stock discount and redemption of preferred stock) by the weighted average number of shares of common stock outstanding during the period. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for the calculation. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options, warrants, restricted stock awards and stock grants. See also Note 4.

 

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Comprehensive Income

 

Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on available-for-sale securities and the net unrecognized actuarial losses and unrecognized prior service costs associated with the Company’s Defined Benefit Postretirement Medical Plan. All items included in other comprehensive income are reported net of tax. See also Notes 5, 16 and 25 and the Consolidated Statements of Comprehensive Income.

 

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Cash Flows

 

Cash and cash equivalents include amounts due from banks and overnight investments with the Federal Home Loan Bank (“FHLB”) and the Federal Reserve. Cash and amounts due from depository institutions include required balances on hand or on deposit at the FHLB and Federal Reserve of approximately $1,809,000$1,723,000 and $1,896,000,$1,048,000, respectively, at December 31, 20162018, to meet regulatory reserve and clearing requirements. Net cash flows are reported for customer loan and deposit transactions, interest bearinginterest-bearing deposits in other financial institutions and repurchase agreements.

 

Investment Securities

 

Management determines the appropriate classification of debt securities at the time of purchase and evaluates such designation as of each balance sheet date. Debt securitiesSecurities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the securities to maturity and are reported at amortized cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity.

 

DebtSecurities available-for-sale consists of those securities not classified as held-to-maturitywhich might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and equity securities are classified as available-for-sale.availability of alternative investments, liquidity needs or other factors. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported in other comprehensive income (loss) until realized. Realized gains and losses are included in gains (losses) on securities or other-than-temporary impairment losses on securities. Realized gains and losses on securities sold are recognized on the trade date based on the specific identification method.

 

Interest income includes amortization of purchase premiums and discounts. Premiums and discounts are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are expected. Securities with unrealized losses are reviewed quarterly to determine if value impairment is other–than-temporary. In performing this review management considers the length of time and extent that fair value has been less than cost, the financial condition of the issuer, the impact of changes in market interest rates on market value and whether the Company intends to sell or it would be more than likely required to sell the securities prior to their anticipated recovery. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) other-than-temporary impairment (“OTTI”) related to credit loss, which must be recognized in the income statement and (2) OTTI related to other factors, which is recognized in other comprehensive income.  The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

 

FHLB Stock

 

First Federal is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. At December 31, 2016,2018, the Company held $13.8$14.2 million at the FHLB of Cincinnati and $5,000$2,500 at the FHLB of Indianapolis.

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Loans Receivable

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal amount outstanding, net of deferred loan fees and costs, purchase premiums and discounts and the allowance for loan losses. Deferred fees net of deferred incremental loan origination costs, are amortized to interest income generally over the contractual life of the loan using the interest method without anticipating prepayments. The recorded investment in loans includes accrued interest receivable, unamortized premiums and discounts, and net deferred fees and costs and undisbursed loan amounts.

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Mortgage loans originated and intended for sale in the secondary market are classified as loans held for sale and are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains or losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

 

The Company may incur losses pertaining to loans sold to Fannie Mae and Freddie Mac but repurchased due to underwriting issues. Repurchase losses are recognized when the Company determines they are probable and estimable.

 

Interest receivable is accrued on loans and credited to income as earned. The accrual of interest on loans 90 days delinquent or those loans considered impaired is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. For these loans, interest accrual is only to the extent cash payments are received. The accrual of interest on these loans is generally resumed after a pattern of repayment has been established and the collection of principal and interest is reasonably assured.

 

AcquiredPurchased Credit Impaired Loans

 

The Company acquires loans individually and in groups or portfolios. At acquisition, the Company reviews each loan to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that it will be unable to collect all amounts due according to the loan’s contractual terms. If both conditions exist, the Company determines whether each such loan is to be accounted for individually or whether such loans will be assembled into pools of loans based on common risk characteristics (credit score, loan type and date of origination). The Company considers expected prepayments, and estimates the amount and timing of undiscounted expected principal, interest, and other cash flows (expected at acquisition) for each loan and subsequently aggregated pool of loans.

 

The Company determines the excess of the loan’s or pool’s scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount that should not be accreted (nonaccretable difference). The remaining amount—representing the excess of the loan’s cash flows expected to be collected over the amount paid—is accreted into interest income over the remaining life of the loan or pool (accretable yield).

 

Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected, and evaluates whether the present value of its loans determined using the effective interest rates has decreased and, if so, recognizes a loss.Valuation allowances for all acquired loans subject to FASB ASCFinancial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310 reflect only those losses incurred after acquisition—that is, the present value of cash flows expected at acquisition that are not expected to be collected.The present value of any subsequent increase in the loan’s or pool’s actual cash flows or cash flows expected to be collected is used first to reverse any existing valuation allowance for that loan or pool. For any remaining increases in cash flows expected to be collected, the Company adjusts the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life.

 

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Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans, actual loss experience, current economic events in specific industries and geographical areas and other pertinent factors, including general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

Beginning June 30, 2015, the Company refined the methodology to its allowance for loan loss calculation pertaining to the general reserve component for non-impaired loans. There was no change to the calculation of the component for reserves on impaired loans. Within the general reserve, the determination of the historical loss component was modified from using a three-year average annual loss rate to a loss migration measurement. The loss migration measurement implemented June 30, 2015, utilized an average of four (4) four-year loss migration periods for each loan portfolio segment with differentiation between loan risk grades. Prior to June 30, 2015, the approach to this component quantified the historical loss by calculating a rolling twelve quarter average annual loss rate for each portfolio segment, without differentiation between loan risk grades. Beginning December 31, 2016 the historical loss calculation was changed from using an average of four (4) four-year loss migration periods to using an average of all four-year loss migration periods to the present beginning with data from the second quarter 2011. Management believes this enhancement is consistent with the rationale of the previous measurement but provides a more precise calculation of historical losses by incorporating more data points for the average loss ratio and including periods that provide a more complete coverage of the full business cycle. Management believes that capturing the risk grade changes and cumulative losses over the life cycle of a loan more accurately depicts management’s estimate of historical losses as well as being more reflective of the ongoing risks in the loan portfolio. These modifications resulted in a change in the general reserves between the loan portfolio segments but did not have a material impact on the overall allowance for loan losses.charged-off.

 

Loan losses are charged offcharged-off against the allowance when in management’s estimation it is unlikely that the loan will be collected, while recoveries of amounts previously charged offcharged-off are credited to the allowance. A provision for loan loss is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors in order to maintain the allowance for loan losses at the level deemed adequate by management. The determination of whether a loan is considered past due or delinquent is based on the contractual payment terms. Loans are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. All loans are placed on nonaccrualnon-accrual status at 90 days past due unless the loan is adequately secured and is in process of collection. Any loan in the portfolio may be placed on nonaccrualnon-accrual status prior to becoming 90 days past due when collection of principal or interest is in doubt.

 

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Impaired loans have been recognized in conformity with FASB ASC Topic 310.

 

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loans agreement. Loans, for which terms have been modified and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. AnWhen a loan is considered impaired, an analysis of the net present value of estimated cash flows is performed and an allowance may be established based on the outcome of that analysis, or if the loan is deemed to be collateral dependent an allowance is established based on the fair value of collateral. All modifications are reviewed by the First Federal’s Chief Credit Officer or Credit Administration Officer to determine whether or not the modification constitutes a troubled debt restructure. Commercial and commercial real estate loansloan relationships greater than $250,000 are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net of the allowance allocation which is determined based on the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Impaired loan relationships less than $250,000 are aggregated by loan segment and risk level and given a specific reserve based on the general reserve factor for that loan segment and risk level. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.

 

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The following portfolio segments have been identified:

 

Commercial Real Estate Loans (consisting of multi-family residential and non-residential): Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans. These loans are viewed primarily as cash flow loans and the repayment of these loans is largely dependent on the successful operation of the property. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.

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Commercial Loans: Commercial credit is extended primarily to middle market customers. Such credits are typically comprised of working capital loans, loans for physical asset expansion, asset acquisition loans and other business loans. Loans to closely held businesses will generally be guaranteed in full or for a meaningful amount by the businesses' principal owners. Commercial loans are made based primarily on the historical and projected cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not behave as forecasted and collateral securing loans may fluctuate in value due to economic or individual performance factors. Minimum standards and underwriting guidelines have been established for all commercial loan types.

 

Consumer Finance Loans: Consumer finance loans are generally made to borrowers for a specific consumer purchase and are made based on their ability to repay with their current debt to income as well as the underlying collateral value of the item being purchased. Credit scores are part of the decision process of whether or not credit is extended. Minimum standards and underwriting guidelines have been established for all consumer loan types.

 

1-4 Family Residential Real Estate Loans: 1-4 family residential real estate loans can be categorized two different ways. One part of this portfolio is owner occupied and loans are made based primarily on the ability of the individual borrower to support the payments as well as the payments of any other debt the borrower may have outstanding at the time the loan is made. The other part of this portfolio is non-owner occupied income producing property and isloans are made primarily based on the cash flow stream from rental income as well as the cash flow support from the borrower’s unrelated cash flow. Both types of loans have a secondary repayment source of the underlying collateral and generally the loans are not extended at higher than an 80% LTV.loan-to-value (“LTV”). Minimum standards and underwriting guidelines have been established for all 1-4 family residential real estate loan types.

 

Construction Loans: The Company defines construction loans as loans where the loan proceeds are controlled by the Company and used exclusively for the improvement of real estate in which the Company holds a mortgage.

 

Home Equity and Improvement Loans: Home Equity and Improvement loans are made to borrowers based on their ability to repay with their current debt to income as well as the underlying collateral value of the real estate taken as security. Minimum standards and underwriting guidelines have been established for all 1-4 family residential real estatehome equity and improvement loan types.

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Consumer finance, 1-4 family residential real estate (including construction) and home equity and improvement loans are subject to adverse employment conditions in the local economy which could increase the default rate on loans.

 

Servicing Rights

 

Servicing rights are recognized separately when they are acquired through sales of loans. Servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. The Company compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interestnoninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans, driven, generally, by changes in market interest rates.

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Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in valuation allowances are reported with mortgage banking incomeonincome on the income statement. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

 

Servicing fee income, which is reported on the income statement with mortgage banking income, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan, and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Servicing fees totaled $3.6$3.8 million, $3.5$3.7 million and $3.6 million for the years ended December 31, 2016, 20152018, 2017 and 2014.2016. Late fees and ancillary fees related to loan servicing are not material. See Note 8.

 

Bank Owned Life Insurance

 

The Company has purchased life insurance policies for certain key employees. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

 

Premises and Equipment and Long Lived Assets

 

Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:

 

Buildings and improvements20 to 50 years
Furniture, fixtures and equipment3 to 15 years

 

Long-lived assets to be held and those to be disposed of and certain intangibles are periodically evaluated for impairment. See Note 9.

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Goodwill and Other Intangibles

 

Goodwill resulting from business combinations prior to January 1, 2009, represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrollingnon-controlling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected November 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on First Defiance’s balance sheet.

 

Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank, insurance and branch acquisitions. They are initially recorded at fair value and then amortized on an accelerated basis over their estimated lives, which range from five years for non-compete agreements to 10 to 20 years for core deposit and customer relationship intangibles. See Note 10.

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Real Estate and Other Assets Held for Sale

 

Real estate and other assets held for sale are comprised of properties or other assets acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. These assets are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Losses arising from the acquisition of such property are charged against the allowance for loan losses at the time of acquisition. These properties are carried at the lower of cost or fair value, less estimated costs to dispose. If fair value declines subsequent to foreclosure, the property is written down against expense. Costs after acquisition are expensed.

 

Stock Compensation Plans

 

Compensation cost is recognized for stock options and restricted share awards issued to employees and directors, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. Restricted shares awards are valued at the market value of Company stock at the date of the grant. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. See Note 20.

 

Fair Value of Financial Instruments

 

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 22. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

 

Transfers of Financial Assets

 

Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

 

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Mortgage Banking Derivatives

 

Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in fair values of these derivatives are included in mortgage banking income.

 

Operating Segments

 

Management considers the following factors in determining the need to disclose separate operating segments: (1) Thethe nature of products and services, which are all financial in nature.nature; (2) Thethe type and class of customer for the products and services; in First Defiance’s case retail customers for retail bank and insurance products and commercial customers for commercial loan, deposit, life, health and property and casualty insurance needs.needs; (3) Thethe methods used to distribute products or provide services; such services are delivered through banking and insurance offices and through bank and insurance customer contact representatives. Retail and commercial customers are frequently targets for both banking and insurance products.products; (4) Thethe nature of the regulatory environment; both banking and insurance entities are subject to various regulatory bodies and a number of specific regulations.

 

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Quantitative thresholds as stated in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)FASB ASC Topic 280,Segment Reporting are monitored. For the year ended December 31, 2016,2018, the reported revenue for First Insurance was 9.2%8.6% of total revenue for First Defiance. Total revenue includes net interest income (before provision for loan losses) plus non-interestnoninterest income. Net income for First Insurance for the year ended December 31, 20162018 was 4.9%4.5% of consolidated net income. Total assets of First Insurance at December 31, 20162018, were 0.6%0.7% of total assets. First Insurance does not meet any of the quantitative thresholds of FASB ASC Topic 280. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable segment.

 

Dividend Restriction

 

Banking regulations require maintaining certain capital levels and may limit the dividends paid by the savings bankFirst Federal to the holding company.First Defiance. See Note 17 for further details on restrictions.

 

Loan Commitments and Related Financial Instruments

 

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

 

Loss Contingencies

 

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any such matters that will have a material effect on the financial statements.

 

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Income Taxes

 

Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Realization of deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

 

In December 2017, a law was enacted which changed the corporate federal income tax rate from 35% to 21%, beginning January 1, 2018. Accordingly, the Company’s deferred tax assets and liabilities were re-measured at December 31, 2017, using the 21% corporate federal income tax rate resulting in a net tax expense of $154,000. An effective tax rate of 35%21% is used to determine after-tax components of other comprehensive income (loss) included in the statements of stockholders’ equity. See Note 18.

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

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Retirement Plans

 

Pension expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Employee 401(k) plan expense is the amount of matching contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service. See Note 16 and 19.

 

Reclassifications

 

Some items in the prior year financial statements were reclassified to conform to the current presentation.presentation which did not result in any changes to net income or equity.

 

Accounting Standards Updates

 

In August 2016,May 2014, the Financial Accounting Standards Board (“FASB”)FASB issued Accounting StandardStandards Update (“ASU”) No. 2016-05 — Statement2014-09, “Revenue from Contracts with Customers.” This standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies generally will be required to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of Cash Flows (Topic 230): Classificationvariable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. Subsequent to the issuance of Certain Cash ReceiptsASU 2014-09, the FASB issued targeted updates to clarify specific implementation issues including ASU No. 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU No. 2016-10, “Identifying Performance Obligations and Cash Payments (a consensusLicensing,” ASU No. 2016-12, “Narrow-Scope Improvements and Practical Expedients,” and ASU No. 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” For financial reporting purposes, this standard allows for either full retrospective adoption, meaning the standard is applied to all of the Emerging Issues Task Force). The amendmentsperiods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in this update providethe financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. Since the guidance on eight specific cash flow issues. Thedoes not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The amendments in this update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company doesdid not believe this standard will have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company completed its consolidated statementsoverall assessment of cash flows.

In June 2016,revenue streams and review of related contracts potentially affected by the FASB issued new accounting guidanceASU, including trust and asset management fees, deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company adopted ASU No. 2016-13, Measurement2014-09 and its related amendments on its required effective date of Credit Losses on Financial Instruments (Topic 326). The main objectiveJanuary 1, 2018, utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the update isnew guidance, a cumulative effect adjustment to provide financial statement usersopening retained earnings was not deemed necessary. See “Revenue Recognition” below for additional information related to revenue generated from contracts with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update replace the incurred loss impairment methodology in current Generally Accepted Accounting Principles with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates. The amendments in this update become effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2019. The Company is currently evaluating the impact of this new accounting standard on the Company's consolidated financial statements. Management’s initial review indicates it has maintained sufficient historical loan data to support the requirement of this pronouncement and is currently evaluating the various loss methodologies to determine their correlations to the Company’s loan segments historical performance.customers.

 

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In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans receivable) on the balance sheet or the accompanying notes to the financial statements; and (8) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The adoption of ASU No. 2016-01 on January 1, 2018, did not have a material impact on the Company’s consolidated financial statements. Also in conjunction with the adoption, the Company’s fair value measurement of financial instruments was based upon an exit price notion as required in ASU 2016-01. The guidance was applied on a prospective approach resulting in prior-periods no longer being comparable.

In February 2018, the FASB issued ASU No. 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This ASU allows a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for certain income tax effects stranded in AOCI as a result of public law No. 115-97, known as the Tax Cuts and Jobs Act (“Tax Act”). Consequently, the reclassification eliminates the stranded tax effects resulting from the Tax Act and is intended to improve the usefulness of information reported to financial statement users. However, because the ASU only relates to the reclassification of the income tax effects of the Tax Act, the underlying guidance that requires the effect of a change in tax laws or rates to be included in income from continuing operations is not affected. The Company adopted ASU No. 2018-02 during the first quarter of 2018, and elected to reclassify the income tax effects of the Tax Act from AOCI to retained earnings. The reclassification increased AOCI and decreased retained earnings by $47,000, with zero net effect on total shareholders’ equity.

 

In February 2016, the FASB issued ASU No. 2016-02 — Leases (Topic 842). The objective of the update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact this standard will have on its financial position and results of operations, though the Company expects that its real estate leases will be recognized on the consolidated balance sheet.

In January 2016, the FASB issuedelected to apply ASU No. 2016-01 — Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2017, and requires a cumulative-effect adjustment to the balance sheet2016-02 as of the beginning of the fiscal yearperiod of adoption. Early adoption is(January 1, 2019) and will not permitted.restate comparative periods. The Company is currently evaluatingalso expect to elect certain optional practical expedients. The Company has implemented a third party software solution to assist with the impact of adoptingaccounting under the new guidance on the consolidated financial statements. Management’s preliminary finding is that the new pronouncement will not have a significant impact on its results of operations.standard. The pronouncement will require some revisionCompany’s operating leases relate primarily to the Company’s disclosures within the consolidated financial statementsoffice space and is currently evaluating the impact.

In May 2014, the FASB issued ASU No. 2014-09 — Revenue from Contracts with Customers, and subsequently has issued five related accounting standard updates clarifying several aspectsbank branches. Upon adoption of ASU 2014-09, including technical corrections and improvements. The overall objective of the new standards updates is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within industries, across industries, and across capital markets. The revenue standard contains principles that will be applied to determine the measurement of revenue and timing of when it is recognized. The Company anticipates adopting the new standard2016-02 on its effective date, January 1, 2018, though2019, the Company has not yet selected whether it would adopt using the retrospective approach with adjustmentsexpects to each prior period or the retrospective method with the cumulative effect of initial application recognized at the date of initial application. While the Company is continuing to assess all potential impacts this standard will have on its financial positionrecognize right-to-use assets and results of operations, early conclusions indicate that these standards will not have a material impact. The implementation efforts include the identification of revenue within the scope of the guidance, as well as the evaluation of revenue contracts.related lease liabilities totaling approximately $8.8 million and $9.3 million, respectively.

 

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3. Acquisitions/Subsequent EventIn June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments.” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s guidance delays recognition of credit losses. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income over time, as they do today. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company continues its implementation efforts through its established Company-wide implementation committee along with a third-party software vendor to assist in the implementation process. The committee’s review indicates the Company has maintained sufficient historical loan data to support the requirement of this pronouncement and is currently evaluating the various loss methodologies to determine their correlations to the Company’s loan segments historical performance. Early adoption is permitted, however, the Company does not currently plan to adopt this ASU early.

 

Revenue Recognition

Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

On August 23, 2016, First Defiance announced

The majority of the executionCompany’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans, letters of a definitive agreement (the “Agreement”)credit, and investment securities, as well as revenue related to acquiremortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within the Company’s disclosures. Descriptions of the Company’s revenue-generating activities that are within the scope of ASC 606, which are presented in the Company’s statement of income as components of noninterest income are as follows:

·Service charges on deposit accounts - these represent general service fees for monthly account maintenance and activity or transaction-based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied. Service charges on deposit accounts that are within the scope of ASC 606 were $7.6 million in 2018. Income from services charges on deposit accounts is included in service fees and other charges in noninterest income.

·Interchange income - this represents fees earned from debit and credit cardholder transactions. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrent with the transaction processing services provided to the cardholder. Interchange fees were $4.1 million in 2018, which are reported net of network related charges. Interchange income is included in service fees and other charges in noninterest income.

·Wealth management and trust fee income - this represents monthly fees due from wealth management customers as consideration for managing the customers’ assets. Wealth management and trust services include custody of assets, investment management, escrow services, and fees for trust services and similar fiduciary activities. Revenue is recognized when our performance obligation is completed each month, which is generally the time that payment is received. Also included are fees received from a third party broker-dealer as part of a revenue-sharing agreement for fees earned from customers that we refer to the third party. These fees are paid to us by the third party on a quarterly basis and recognized ratably throughout the quarter as our performance obligation is satisfied. Revenue from wealth management and trust services were $821,000 and $2.1 million, respectively, in 2018. Income from wealth management services is included in other noninterest income in total noninterest income. Trust fees are reported separately in total noninterest income.

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·Gain/loss on sales of other real estate owned (“OREO”) - the Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain or loss on sale if a significant financing component is present. Income from the gain/loss on sales of OREO was a loss of $28,000 in 2018. Income from the gain or loss on sales of OREO is included in other noninterest income in total noninterest income.

·Insurance commissions - this represents new commissions that are recognized when the Company sells insurance policies to customers. The Company is also entitled to renewal commissions and, in some cases, contingent commissions in the form of profit sharing which are recognized in subsequent periods. The initial commission is recognized when the insurance policy is sold to a customer. Renewal commission is variable consideration and is recognized in subsequent periods when the uncertainty around variable consideration is subsequently resolved (i.e., when customer renews the policy). Contingent commission is also a variable consideration that is not recognized until the variability surrounding realization of revenue is resolved. Another source of variability is the ability of the policy holder to cancel the policy anytime and in such cases, the Company may be required, under the terms of the contract, to return part of the commission received. The variability related to cancellation of the policy is not deemed significant and thus, does not impact the amount of revenue recognized. In the event the policyholder chooses to cancel the policy at any time, the revenue for amounts which qualify for claw-back are reversed in the period the cancellation occurs. Management views the income sources from insurance commissions in two categories: (i) new/renewal commissions and (ii) contingent commissions. Insurance commissions were $14.1 million for 2018, of which, $13.1 million were new/renewal commissions and $1.0 million were contingent commissions.

3. Business Combinations

Effective February 24, 2017, the Company acquired Commercial Bancshares, Inc. (“Commercial Bancshares”) and its wholly-owned subsidiary, theThe Commercial Savings Bank (“CSB”)., pursuant to an Agreement and Plan of Merger (“Merger Agreement”), dated August 23, 2016. The transaction closed onacquisition was accomplished by the merger of Commercial Bancshares into First Defiance, immediately followed by the merger of CSB into First Federal. CSB operated seven full-service banking offices in northwest and north central, Ohio and one commercial loan production office in central Ohio. Commercial Bancshares’ consolidated assets and equity (unaudited) as of February 24, 2017, totaled $348.4 million and $37.5 million, respectively. The Company accounted for the transaction under the acquisition method of accounting which means that the acquired assets and liabilities were recorded at fair value at the date of acquisition. The fair value included in these financial statements is based on final valuations.

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In accordance with ASC 805, the Company expensed approximately $3.7 million of direct acquisition costs, of which $2.8 million was to settle employment and benefit agreements and for personnel expenses related to operating the new Commercial Bancshares locations. The Company recorded $28.9 million of goodwill and $4.9 million of intangible assets. Goodwill represents the future economic benefits arising from net assets acquired that are not individually identified and separately recognized and is attributable to synergies expected to be derived from the combination of the two entities. The acquisition was consistent with the Company’s strategy to enhance and expand its presence in northwestern and central Ohio. The acquisition offered the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded market area. The intangible assets were related to core deposits and are being amortized over 10 years on an accelerated basis. For tax purposes, goodwill totaling $28.9 million is non-deductible. Goodwill is evaluated annually for impairment. The following table summarizes the fair value of the total consideration transferred as part of the Commercial Bancshares acquisition as well as the fair value of identifiable assets and liabilities assumed as of the effective date of the transaction.

  February 24, 2017 
  (In Thousands) 
    
Cash Consideration $12,340 
Equity – Dollar Value of Issued Shares  56,532 
Fair Value of Total Consideration Transferred  68,872 
     
Recognized Amounts of Identifiable Assets Acquired and Liabilities Assumed:    
Cash and Cash Equivalents  35,411 
Federal Funds Sold  2,769 
Securities  4,338 
Loans  285,448 
FHLB Stock of Cincinnati and Other Stock  2,194 
Office Properties and Equipment  5,256 
Intangible Assets  4,900 
Bank-Owned Life Insurance  8,168 
Accrued Interest Receivable and Other Assets  3,606 
Deposits – NonInterest-Bearing  (56,061)
Deposits – Interest-Bearing  (251,931)
Advances from FHLB  (1,403)
Accrued Interest Payable and Other Liabilities  (2,717)
Total Identifiable Net Assets  39,978 
     
Goodwill $28,894 

Under the terms of the Merger Agreement, Commercial Bancshares common shareholders had the opportunity to elect to receive 2.3616 shares of common stock of the Company or cash in the amount of $51.00 for each share of Commercial Bancshares common stock, subject to adjustment as provided for in the merger agreement. Total consideration for Commercial Bancshares common shares outstanding was paid 80% in Company stock and 20% in cash. The Company issued 2,279,004 shares of its common stock and paid $12.3 million in cash to the former shareholders of Commercial Bancshares.

The following table presents unaudited pro forma information as if the acquisition had occurred on January 1, 2016, after giving effect to certain adjustments. The unaudited pro forma information for the twelve months ended December 31, 2017, and December 31, 2016, includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, interest expense on deposits and borrowings acquired, and the related income tax effects. The unaudited pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transaction been effected on the assumed date.

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  Pro Forma Twelve  Pro Forma Twelve 
  Months Ended  Months Ended 
  December 31, 2017  December 31, 2016 
  (In Thousands, except per share data) 
       
Net Interest Income $98,856  $90,452 
Provision for loan losses  2,949   753 
Noninterest Income  40,338   35,496 
Noninterest Expense  82,597   76,393 
Income Before Income Taxes  53,648   48,802 
Income Tax Expense  17,780   15,276 
Net Income $35,868  $33,526 
Diluted Earnings Per Share $3.51  $3.29 

The above pro forma financial information includes approximately $4.6 million of net income related to the operations of Commercial Bancshares during the twelve months of 2017. The above pro forma financial information related to 2017 excludes merger related costs that totaled $3.7 million on a pre-tax basis.

On April 13, 2017, First Defiance and Corporate One Benefits Agency, Inc. (“Corporate One”) jointly announced the acquisition of Corporate One’s business by First Defiance. The total purchase price paid in cash was made up of the following: $6.5 million was paid at closing, $500,000 was due and paid the second quarter of 2018, and up to $2.3 million may be due at the end of a three-year earn-out based on the compound annual growth rate of net revenue over the performance period of Corporate One, for Commercial Bancsharesa total maximum purchase price of $9.3 million. The recorded fair value of the $2.3 million earn-out was $70.3$1.8 million at December 31, 2017. As of December 31, 2017, the Company recorded goodwill of $7.9 million as well as identifiable intangible assets of $756,000 consisting of $13.8 milliona customer relationship intangible of cash$564,000 and cash payment to cancel outstanding options and the issuancea non-compete intangible of 1.1 million shares of First Defiance Common Stock valued at $56.5 million. The Company expects to record goodwill arising from the acquisition consisting largely of synergies and cost savings resulting from combining the operations of the companies. The amount of goodwill is not expected to be deductible for tax purposes.$192,000. The fair value of intangible assets and acquired assets and liabilities will be determined as of the acquisition date but are still being evaluated as of the date ofincluded in these financial statements.statements is based on final valuation. Corporate One was a full-service employee benefits consulting organization founded in 1996 with offices located in Archbold, Findlay, Fostoria and Tiffin, Ohio. Corporate One consulted employers to better manage their employee benefit programs to effectively lead them into the future. The purpose of the acquisition is to extend the Company’s growing market areatransaction enhanced employee benefit offerings and expanded First Insurance’s presence into central Ohio supporting the Company’s overall strategic plan.adjacent markets in northwest Ohio.

 

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4. Earnings Per Common Share

 

Basic earnings per share is calculated using the two-class method. The two-class method is an earnings allocation formula under which earnings per share is calculated from common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings distributed and undistributed, are allocated to participating securities and common shares based on their respective rights to receive dividends. Unvested share-based payment awards that contain non-forfeitable rights to dividends are considered participating securities (i.e. unvested restricted stock), not subject to performance based measures.

 

The following table sets forth the computation of basic and diluted earnings per common share:share for the years ended December 31:

 

  2016  2015  2014 
  (In Thousands, Except Per Share Amounts) 
Basic Earnings Per Share:         
Net income available to common shareholders $28,843  $26,423  $24,292 
Less: Income allocated to participating securities  39   8   4 
Net income allocated to common shareholders  28,804   26,415   24,288 
             
Weighted average common shares outstanding
Including participating securities
  8,980   9,221   9,511 
Less: Participating securities  11   11   6 
Average common shares  8,969   9,210   9,505 
             
Basic earnings per common share $3.21  $2.87  $2.55 
             
Diluted Earnings Per Share:            
Net income allocated to common shareholders $28,804  $26,415  $24,288 
Weighted average common shares outstanding
for basic earnings per common share
  8,969   9,210   9,505 
Add: Dilutive effects of stock options  66   87   111 
Add: Dilutive effects of warrants  -   75   353 
Average shares and dilutive potential common shares  9,035   9,371   9,969 
             
Diluted earnings per common share $3.19  $2.82  $2.44 

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  2018  2017  2016 
  (In Thousands, Except Per Share Amounts) 

Basic Earnings Per Share:

Net income available to common shareholders

 $46,249  $32,268  $28,843 
Less: Income allocated to participating securities  16   5   39 
Net income allocated to common shareholders $46,233  $32,263  $28,804 
             
Weighted average common shares outstanding Including participating securities  20,358   19,950   17,960 
Less: Participating securities  9   18   22 
Average common shares  20,349   19,932   17,938 
             
Basic earnings per common share $2.27  $1.62  $1.61 
             
Diluted Earnings Per Share:            
Net income allocated to common shareholders $46,233  $32,263  $28,804 
Weighted average common shares outstanding for basic earnings per common share  20,349   19,932   17,938 
Add: Dilutive effects of stock options  119   124   132 
Average shares and dilutive potential common shares  20,468   20,056   18,070 
             
Diluted earnings per common share $2.26  $1.61  $1.60 

 

Shares subject to issue upon exercise of options of 12,550 in 2016, 8,750 in 2015 and 10,500 in 20142018, zero in 2017 and 25,100 in 2016 were excluded from the diluted earnings per common share calculation as they were anti-dilutive.

- 83 -

 

5. Investment Securities

 

The following tables summarize the amortized cost and fair value of available-for-sale securities and held-to-maturity investment securities at December 31, 20162018 and 20152017, and the corresponding amounts of gross unrealized and unrecognized gains and losses:

 

    Gross Gross        Gross Gross    
 Amortized Unrealized Unrealized Fair  Amortized Unrealized Unrealized Fair 
 Cost  Gains  Losses  Value  Cost  Gains  Losses  Value 
 (In Thousands)  (In Thousands) 
2016         
2018         
Available-for-sale                                
Obligations of U.S. government corporations and agencies $4,000  $-  $(85) $3,915  $2,519  $2  $(18) $2,503 
Mortgage-backed securities - residential  82,619   390   (1,302)  81,707   76,165   111   (1,566)  74,710 
REMICs  1,309   -   (2)  1,307   2,712   4   (7)  2,709 
Collateralized mortgage obligations  63,204   422   (621)  63,005 
Preferred stock  -   2   -   2 
Collateralized mortgage obligations - residential  103,026   124   (1,689)  101,461 
Corporate bonds  12,919   97   (3)  13,013   12,910   44   (148)  12,806 
Obligations of state and political
subdivisions
  86,165   2,491   (613)  88,043   99,349   1,258   (720)  99,887 
Total Available-for-Sale $250,216  $3,402  $(2,626) $250,992  $296,681  $1,543  $(4,148) $294,076 

 

    Gross Gross        Gross Gross    
 Amortized Unrecognized Unrecognized Fair  Amortized Unrecognized Unrecognized Fair 
 Cost  Gains  Losses  Value  Cost  Gains  Losses  Value 
 (In Thousands)  (In Thousands) 
Held-to-Maturity                                
FHLMC certificates $12  $-  $-  $12  $8  $-  $-  $8 
FNMA certificates  56   2   -   58   31                          -                           -   31 
GNMA certificates  23   1   -   24   12   -   -   12 
Obligations of states and political subdivisions  93   -   -   93   475   -   -   475 
Total Held-to-Maturity $184  $3  $-  $187  $526  $-  $-  $526 

     Gross  Gross    
  Amortized  Unrealized  Unrealized  Fair 
  Cost  Gains  Losses  Value 
  (In Thousands) 
2017            
Available-for-sale                
Obligations of U.S. government corporations and agencies $518  $-  $(10) $508 
Mortgage-backed securities - residential  59,942   90   (763)  59,269 
REMICs  1,072   -   (7)  1,065 
Collateralized mortgage obligations - residential  94,588   180   (892)  93,876 
Preferred stock  -   1   -   1 
Corporate bonds  12,914   189   -   13,103 
Obligations of state and political subdivisions  90,692   2,426   (290)  92,828 
Total Available-for-Sale $259,726  $2,886  $(1,962) $260,650 

 

 - 7884 - 

 

 

     Gross  Gross    
  Amortized  Unrealized  Unrealized  Fair 
  Cost  Gains  Losses  Value 
  (In Thousands) 
2015            
Available-for-sale                
Obligations of U.S. government corporations and agencies $3,000  $1  $(7) $2,994 
Mortgage-backed securities - residential  63,815   898   (59)  64,654 
REMICs  1,592   28   -   1,620 
Collateralized mortgage obligations  71,176   976   (353)  71,799 
Preferred stock  -   1   -   1 
Corporate bonds  4,955   39   (17)  4,977 
Obligations of state and political
subdivisions
  85,680   4,712   (2)  90,390 
Total Available-for-Sale $230,218  $6,655  $(438) $236,435 

   Gross Gross      Gross Gross   
 Amortized Unrecognized Unrecognized Fair  Amortized Unrecognized Unrecognized Fair 
 Cost Gains Losses Value  Cost Gains Losses Value 
 (In Thousands)  (In Thousands) 
Held-to-Maturity                                
FHLMC certificates $14  $-  $-  $14  $10  $-  $-  $10 
FNMA certificates  74   2   (1)  75   41   1   -   42 
GNMA certificates  31   1   -   32   17                          -                          -   17 
Obligations of states and political subdivisions  124   -   -   124   580   -   -   580 
Total Held-to-Maturity $243  $3  $(1) $245  $648  $1  $-  $649 

 

The amortized cost and fair value of the investment securities portfolio at December 31, 20162018, is shown below by contractual maturity. Expected maturities will differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. For purposes of the maturity tables below, mortgage-backed securities and collateralized mortgage obligations, which are not due at a single maturity date, have not been allocated over maturity groupings.

 

  Available-for-Sale 
  Amortized  Fair 
  Cost  Value 
  (In Thousands) 
2016      
Available-for-sale        
Due in one year or less $577  $586 
Due after one year through
five years
  21,850   22,136 
Due after five years through
ten years
  41,311   42,784 
Due after ten years  39,346   39,467 
MBS/CMO/REMIC  147,132   146,019 
Total $250,216  $250,992 
Held-to-maturity        
Due after one year through
five years
 $93  $93 
MBS  91   94 
Total $184  $187 

- 79 -

  Available-for-Sale 
  Amortized  Fair 
  Cost  Value 
  (In Thousands) 
2018      
Available-for-sale        
Due in one year or less $771  $773 
Due after one year through
five years
  22,957   22,969 
Due after five years through
ten years
  34,245   34,904 
Due after ten years  56,805   56,550 
MBS/CMO/REMIC  181,903   178,880 
Total $296,681  $294,076 
         
Held-to-maturity        
Due in one year or less $31  $31 
Due after five years through ten years  444   444 
MBS  51   51 
Total $526  $526 

 

Securities pledged at year-end 20162018 and 20152017 had a carrying amount of $142.6$143.9 million and $134.8$135.4 million, respectively, and were pledged to secure public deposits, securities sold under repurchase agreements and FHLB advances.

 

As of December 31, 2016,2018, the Company’s investment portfolio consisted of 383438 securities, 117177 of which were in an unrealized loss position. The Company did not hold any single security that was greater than 10% of the Company’s equity at December 31, 2016.2018.

- 85 -

 

The following table summarizes First Defiance’s securities that were in an unrealized loss position at December 31, 20162018, and December 31, 2015:2017:

 

 Duration of Unrealized Loss Position     Duration of Unrealized Loss Position    
 Less than 12 Months  12 Months or Longer  Total  Less than 12 Months 12 Months or Longer Total 
    Gross     Gross          Gross     Gross      
 Fair Unrealized Fair Unrealized Fair Unrealized  Fair Unrealized Fair Unrealized Fair Unrealized 
 Value  Loss  Value  Loss  Value  Loses  Value Loss Value Loss Value Loses 
 (In Thousands)  (In Thousands) 
At December 31, 2016             
At December 31, 2018                        
Available-for-sale securities:                                                
Obligations of U.S. government corporations and agencies $3,915  $(85) $-  $-  $3,915  $(85) $-  $-  $500  $(18) $500  $(18)
Mortgage-backed securities-residential  63,736   (1,302)  -   -   63,736   (1,302)  11,589   (71)  48,665   (1,495)  60,254   (1,566)
REMICs  1,308   (2)  -   -   1,308   (2)
REMIC’s  -   -   857   (7)  857   (7)
Collateralized mortgage obligations  28,882   (566)  1,227   (55)  30,110   (621)  11,613   (53)  70,585   (1,636)  82,198   (1,689)
Corporate bonds  -   -   997   (3)  997   (3)
Corporate Bonds  5,752   (148)  -   -   5,752   (148)
Obligations of state and political subdivisions  19,172   (613)  -   -   19,172   (613)  11,974   (69)  16,492   (651)  28,466   (720)
Held to maturity securities:  8   -   26   -   34   - 
Total temporarily impaired securities $117,013  $(2,568) $2,224  $(58) $119,238  $(2,626) $40,936  $(341) $137,125  $(3,807) $178,061  $(4,148)
                                                
At December 31, 2015                        
At December 31, 2017                        
Available-for-sale securities:                                                
Obligations of U.S. government corporations and agencies $993  $(7) $-  $-  $993  $(7) $-  $-  $508  $(10) $508  $(10)
Mortgage-backed securities-residential  12,525   (59)  -   -   12,525   (59)  27,881   (215)  19,038   (548)  46,919   (763)
REMIC’s  1,065   (7)  -   -   1,065   (7)
Collateralized mortgage obligations  12,374   (150)  8,158   (203)  20,532   (353)  49,107   (320)  20,804   (572)  69,911   (892)
Corporate bonds  983   (17)  -   -   983   (17)
Obligations of state and political subdivisions  -   -   433   (2)  433   (2)  14,249   (163)  3,370   (127)  17,619   (290)
Held to maturity securities:                          12   -   9   -   21   - 
FNMA certificates  13   (1)  -   -   13   (1)
Total temporarily impaired securities $26,888  $(234) $8,591  $(205) $35,479  $(439) $92,314  $(705) $43,729  $(1,257) $136,043  $(1,962)

 

Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment portfolio is evaluated for OTTI by segregating the portfolio into two general segments. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under FASB ASC Topic 320. Certain collateralized debt obligations (“CDOs”) are evaluated for OTTI under FASB ASC Topic 325,Investment – Other.

- 80 -

 

When OTTI occurs under either model, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected compared to the book value of the security and is recognized in earnings. The amount of OTTI related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.

 

With the exception of corporate bonds, the securities all have fixed interest rates, and all securities have defined maturities. Their fair value is sensitive to movements in market interest rates. First Defiance has the ability and intent to hold these investments for a time necessary to recover the amortized cost without impacting its liquidity position and it is not more than likely that the Company will be required to sell the investments before anticipated recovery.

 

- 86 -

In 2016, 20152018, 2017 and 2014,2016, management determined there was no OTTI. In 2013, management determined that two CDOs had OTTI because they were disallowed under the Final Interim Volcker Rule of the Dodd-Frank Act released on January 14, 2014. The Company sold these two securities on January 15, 2014.

 

There waswere no OTTI recognized in accumulated other comprehensive income (“AOCI”) relating to the CDOs at December 31, 2016 and 2015.

The table below presents a roll-forward of the credit losses relating to debt securities recognized in earnings for the years ended December 31, 2016, 20152018, 2017 and 2014 (In Thousands):2016.

  2016  2015  2014 
Beginning balance, January 1 $-  $-  $3,513 
Additions for amounts related to credit loss for which an OTTI was not previously recognized  -   -   - 
             
Reductions for amounts realized for securities sold/redeemed during the period  -   -   (3,513)
             
Ending balance, December 31 $-  $-  $- 

 

Realized gains from the sales and calls of investment securities totaled $509,000$173,000 ($331,000136,000 after tax) in 20162018 while there were realized gains of $22,000$584,000 ($15,000380,000 after tax) and $932,000$509,000 ($652,000331,000 after tax) in 20152017 and 2014,2016, respectively.

 

The proceeds from sales and calls of securities and the associated gains and losses for the years ended December 31 are listed below:

 

  2016  2015  2014 
  (In Thousands) 
Proceeds $14,871  $426  $14,913 
Gross realized gains  509   22   1,574 
Gross realized losses  -   -   (642)

- 81 -

  2018  2017  2016 
  (In Thousands) 
Proceeds $5,503  $34,248  $14,871 
Gross realized gains  178   665   509 
Gross realized losses  (5)  (81)  - 

 

6. Commitments and Contingent Liabilities

 

Loan Commitments

Loan commitments are made to accommodate the financial needs of First Federal’s customers. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. They primarily are issued to facilitate customers’ trade transactions.

 

Both arrangements have credit risk, essentially the same as that involved in extending loans to customers, and are subject to the Company’s normal credit policies. Collateral (e.g., securities, receivables, inventory and equipment) is obtained based on management’s credit assessment of the customer.

 

The Company’s maximum obligation to extend credit for loan commitments (unfunded loans and unused lines of credit) and standby letters of credit outstanding on December 31 was as follows (In Thousands):

 

 2016  2015  2018 2017 
 Fixed Rate  Variable Rate  Fixed Rate Variable Rate  Fixed Rate Variable Rate Fixed Rate Variable Rate 
Commitments to make loans $34,432  $106,356  $80,862  $76,253  $44,352  $114,308  $42,458  $161,778 
Unused lines of credit  14,384   400,542   31,991   323,171   7,523   382,189   6,245   408,831 
Standby letters of credit  -   9,668   -   19,632   -   7,239   -   7,605 
Total $48,816  $516,566  $112,853  $419,056  $51,875  $503,736  $48,703  $578,214 

 

Commitments to make loans are generally made for periods of 60 days or less. The fixed rate loan commitments at December 31, 20162018, had interest rates ranging from 2.63%3.25% to 18.00% and maturities ranging from less than 1one year to 30 years.

 

In addition to the above commitments, at December 31, 2016,2018, First Defiance had commitments to sell $22.5$8.6 million of loans to Freddie Mac, Fannie Mae, or FHLB of Cincinnati or BB&T Mortgage.Cincinnati.

 

 - 8287 - 

 

 

7. Loans

 

Loans receivable consist of the following:

 

 December 31,
2016
  December 31,
2015
  December 31,
2018
  December 31,
2017
 
 (In Thousands)  (In Thousands) 
Real Estate:             
Secured by 1-4 family residential $207,550  $205,330  $322,686  $274,862 
Secured by multi-family residential  196,983   167,558   278,358   248,092 
Secured by commercial real estate  843,579   780,870   1,126,452   987,129 
Construction  182,886   163,877   265,772   265,476 
  1,430,998   1,317,635   1,993,268   1,775,559 
Other Loans:                
Commercial  469,055   419,349   509,577   526,142 
Home equity and improvement  118,429   116,962   128,152   135,457 
Consumer Finance  16,680   16,281   34,405   29,109 
  604,164   552,592   672,134   690,708 
Total loans  2,035,162   1,870,227   2,665,402   2,466,267 
Deduct:                
Undisbursed loan funds  (93,355)  (66,902)  (123,293)  (115,972)
Net deferred loan origination fees and costs  (1,320)  (1,108)  (2,070)  (1,582)
Allowance for loan loss  (25,884)  (25,382)  (28,331)  (26,683)
Totals $1,914,603  $1,776,835  $2,511,708  $2,322,030 

 

Loan segments have been identified by evaluating the portfolio based on collateral and credit risk characteristics.

- 88 -

 

The following table discloses the year-to-date activity in the allowance for loan loss for the dates indicated by portfolio segment (In Thousands):

 

Year to Date December 31,
2016
 1-4 Family
Residential
Real Estate
 Multi- Family
Residential
Real Estate
 Commercial
Real Estate
 Construction Commercial Home Equity
and
Improvement
 Consumer
Finance
 Total 
Year to Date December 31,
2018
 1-4 Family
Residential
Real Estate
  Multi- Family
Residential
Real Estate
  Commercial
Real Estate
  Construction  Commercial  Home Equity
and
Improvement
  Consumer
Finance
  Total 
Beginning Allowance $3,212  $2,151  $11,772  $517  $5,255  $2,304  $171  $25,382  $2,532 $2,702 $10,354 $647 $7,965 $2,255 $228 $26,683 
Charge-Offs  (350)  -   (92)  -   (615)  (268)  (94)  (1,419)  (261)  -   (1,387)  -   (724)  (269)  (233)  (2,874)
Recoveries  166   -   923   -   335   150   64   1,638   131   57   720   -   2,221   191   26   3,346 
Provisions  (401)  77   (1,978)  (67)  2,386   200   66   283   479   342   2,354   35   (2,181)  (151)  298   1,176 
Ending Allowance $2,627  $2,228  $10,625  $450  $7,361  $2,386  $207  $25,884  $2,881  $3,101  $12,041  $682  $7,281  $2,026  $319  $28,331 

 

Year to Date December 31,
2015
 1-4 Family
Residential
Real Estate
 Multi- Family
Residential
Real Estate
 Commercial
Real Estate
 Construction Commercial Home Equity
and
Improvement
 Consumer
Finance
 Total 
Year to Date December 31,
2017
 1-4 Family
Residential
Real Estate
  Multi- Family
Residential
Real Estate
  Commercial
Real Estate
  Construction  Commercial  Home Equity
and
Improvement
  Consumer
Finance
  Total 
Beginning Allowance $2,494  $2,453  $11,268  $221  $6,509  $1,704  $117  $24,766  $2,627 $2,228 $10,625 $450 $7,361 $2,386 $207 $25,884 
Charge-Offs  (283)  (114)  (353)  -   (68)  (350)  (53)  (1,221)  (279)  -   (429)  -   (2,301)  (301)  (139)  (3,449)
Recoveries  214   -   915   -   331   188   53   1,701   115   32   657   -   243   167   85   1,299 
Provisions  787   (188)  (58)  296   (1,517)  762   54   136   69   442   (499)  197   2,662   3   75   2,949 
Ending Allowance $3,212  $2,151  $11,772  $517  $5,255  $2,304  $171  $25,382  $2,532  $2,702  $10,354  $647  $7,965  $2,255  $228  $26,683 

Year to Date December 31,
2016
 1-4 Family
Residential
Real Estate
  Multi- Family
Residential
Real Estate
  Commercial
Real Estate
  Construction  Commercial  Home Equity
and
Improvement
  Consumer
Finance
  Total 
Beginning Allowance $3,212  $2,151  $11,772  $517  $5,255  $2,304  $171  $25,382 
Charge-Offs  (350)  -   (92)  -   (615)  (268)  (94)  (1,419)
Recoveries  166   -   923   -   335   150   64   1,638 
Provisions  (401)  77   (1,978)  (67)  2,386   200   66   283 
Ending Allowance $2,627  $2,228  $10,625  $450  $7,361  $2,386  $207  $25,884 

 

 - 83 -

Year to Date December 31,
2014
 1-4 Family
Residential
Real Estate
  Multi- Family
Residential
Real Estate
  Commercial
Real Estate
  Construction  Commercial  Home Equity
and
Improvement
  Consumer
Finance
  Total 
Beginning Allowance $2,847  $2,508  $12,000  $134  $5,678  $1,635  $148  $24,950 
Charge-Offs  (426)  -   (1,018)  -   (2,982)  (392)  (41)  (4,859)
Recoveries  188   7   2,670   -   435   193   65   3,558 
Provisions  (115)  (62)  (2,384)  87   3,378   268   (55)  1,117 
Ending Allowance $2,494  $2,453  $11,268  $221  $6,509  $1,704  $117  $24,766 

- 8489 - 

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2016:2018: (In Thousands)

 

 1-4 Family Multi Family             
 Residential Residential Commercial     Home Equity Consumer    1-4 Family Multi Family             
 Real Estate Real Estate Real Estate Construction Commercial & Improvement Finance Total  Residential Residential Commercial     Home Equity Consumer   
                  Real Estate  Real Estate  Real Estate  Construction  Commercial  & Improvement  Finance  Total 
Allowance for loan losses:                                                                
                                                                
Ending allowance balance attributable to loans:                                                                
                                                                
Individually evaluated for impairment $202  $4  $255  $-  $35  $313  $-  $809  $175  $3  $95  $-  $79  $242  $1  $595 
                                                                
Collectively evaluated for impairment  2,425   2,224   10,370   450   7,326   2,073   207   25,075   2,706   3,098   11,946   682   7,202   1,784   318   27,736 
                                                                
Acquired with deteriorated credit quality  -   -   -   -   -   -   -   -   -   -   -   -   -   -   -   - 
                                                                
Total ending allowance balance $2,627  $2,228  $10,625  $450  $7,361  $2,386  $207  $25,884  $2,881  $3,101  $12,041  $682  $7,281  $2,026  $319  $28,331 
                                                                
Loans:                                                                
                                                                
Loans individually evaluated for impairment $6,898  $3,483  $13,570  $-  $2,154  $1,269  $59  $27,433  $6,774  $1,347  $26,334  $-  $10,477  $963  $45  $45,940 
                                                                
Loans collectively evaluated for impairment  200,907   193,714   832,446   89,244   468,246   117,744   16,625   1,918,926   315,385   277,105   1,102,355   142,096   500,730   128,065   34,486   2,500,222 
                                                                
Loans acquired with deteriorated credit quality  -   -   -   -   11   -   -   11   1,012   296   846   -   177   -   -   2,331 
                                                                
Total ending loans balance $207,805  $197,197  $846,016  $89,244  $470,411  $119,013  $16,684  $1,946,370  $323,171  $278,748  $1,129,535  $142,096  $511,384  $129,028  $34,531  $2,548,493 

 

 - 8590 - 

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2015:2017: (In Thousands)

 

 1-4 Family Multi Family             
 Residential Residential Commercial     Home Equity Consumer    1-4 Family Multi Family             
 Real Estate Real Estate Real Estate Construction Commercial & Improvement Finance Total  Residential Residential Commercial     Home Equity Consumer   
                  Real Estate  Real Estate  Real Estate  Construction  Commercial  & Improvement  Finance  Total 
Allowance for loan losses:                                                                
                                                                
Ending allowance balance attributable to loans:                                                                
                                                                
Individually evaluated for impairment $201  $-  $139  $-  $63  $34  $-  $437  $167  $7  $118  $-  $187  $279  $-  $758 
                                                                
Collectively evaluated for impairment  3,011   2,151   11,633   517   5,192   2,270   171   24,945   2,365   2,695   10,236   647   7,778   1,976   228   25,925 
                                                                
Acquired with deteriorated credit quality  -   -   -   -   -   -   -   -   -   -   -   -   -   -   -   - 
                                                                
Total ending allowance balance $3,212  $2,151  $11,772  $517  $5,255  $2,304  $171  $25,382  $2,532  $2,702  $10,354  $647  $7,965  $2,255  $228  $26,683 
                                                                
Loans:                                                                
                                                                
Loans individually evaluated for impairment $7,574  $3,313  $23,493  $-  $6,107  $1,491  $71  $42,049  $6,910  $2,278  $31,821  $-  $14,373  $1,176  $50  $56,608 
                                                                
Loans collectively evaluated for impairment  198,106   164,382   759,281   96,845   414,527   115,977   16,199   1,765,317   267,377   245,823   956,238   149,174   513,218   135,098   29,125   2,296,053 
                                                                
Loans acquired with deteriorated credit quality  -   -   153   -   16   -   -   169   1,069   301   2,121   -   337   -   -   3,828 
                                                                
Total ending loans balance $205,680  $167,695  $782,927  $96,845  $420,650  $117,468  $16,270  $1,807,535  $275,356  $248,402  $990,180  $149,174  $527,928  $136,274  $29,175  $2,356,489 

 

 - 8691 - 

 

 

The following tables presents the average balance, interest income recognized and cash basis income recognized on impaired loans by class of loans for the years ended December 31, 2016, 20152018, 2017 and 2014 (In2016

(In Thousands):

 

 Twelve Months Ended December 31,
2016
  Twelve Months Ended December 31, 2018 
 Average
Balance
  Interest
Income
Recognized
  Cash Basis
Income
Recognized
  Average
Balance
  Interest
Income
Recognized
  Cash Basis
Income
Recognized
 
Residential Owner Occupied $3,954  $244  $237  $4,704  $151  $150 
Residential Non Owner Occupied  3,133   211   210   2,354   133   126 
Total 1-4 Family Residential Real Estate  7,087   455   447   7,058   284   276 
Multi-Family Residential Real Estate  3,946   124   123   1,644   90   89 
CRE Owner Occupied  6,925   203   183   9,992   234   221 
CRE Non Owner Occupied  5,351   411   407   2,620   94   93 
Agriculture Land  2,283   128   68   13,827   575   575 
Other CRE  1,632   71   70   1,304   106   106 
Total Commercial Real Estate  16,191   813   728   27,743   1,009   995 
Construction  -   -   -   -   -   - 
Commercial Working Capital  1,606   109   90   8,047   256   245 
Commercial Other  2,393   81   79   3,501   119   119 
Total Commercial  3,999   190   169   11,548   375   364 
Home Equity and Home Improvement  1,543   85   83   1,150   38   38 
Consumer Finance  67   8   8   39   4   4 
Total Impaired Loans $32,833  $1,675  $1,558  $49,182  $1,800  $1,766 

 

 - 8792 - 

 

 

  Twelve Months Ended December 31,
2015
 
  Average
Balance
  Interest
Income
Recognized
  Cash Basis
Income
Recognized
 
Residential Owner Occupied $6,985  $246  $244 
Residential Non Owner Occupied  5,444   152   152 
Total 1-4 Family Residential Real Estate  12,429   398   396 
Multi-Family Residential Real Estate  3,799   40   40 
CRE Owner Occupied  9,019   168   167 
CRE Non Owner Occupied  10,125   349   348 
Agriculture Land  2,980   88   56 
Other CRE  3,554   81   80 
Total Commercial Real Estate  25,678   686   651 
Construction  50   2   2 
Commercial Working Capital  2,217   58   56 
Commercial Other  4,773   49   49 
Total Commercial  6,990   107   115 
Home Equity and Home Improvement  2,757   62   62 
Consumer Finance  80   14   14 
Total Impaired Loans $51,783  $1,309  $1,270 

  Twelve Months Ended December 31, 2017 
  Average
Balance
  Interest
Income
Recognized
  Cash Basis
Income
Recognized
 
Residential Owner Occupied $3,811  $138  $138 
Residential Non Owner Occupied  3,038   138   138 
Total 1-4 Family Residential Real Estate  6,849   276   276 
Multi-Family Residential Real Estate  2,471   58   58 
CRE Owner Occupied  10,592   110   109 
CRE Non Owner Occupied  3,768   140   133 
Agriculture Land  9,667   472   229 
Other CRE  1,603   76   70 
Total Commercial Real Estate  25,630   798   541 
Construction  -   -   - 
Commercial Working Capital  5,235   129   123 
Commercial Other  5,940   109   79 
Total Commercial  11,175   238   202 
Home Equity and Home Improvement  1,217   43   43 
Consumer Finance  59   4   4 
Total Impaired Loans $47,401  $1,417  $1,124 

 

 - 8893 - 

 

 

 Twelve Months Ended December 31,
2014
  Twelve Months Ended December 31, 2016 
 Average
Balance
  Interest
Income
Recognized
  Cash Basis
Income
Recognized
  Average
Balance
  Interest
Income
Recognized
  Cash Basis
Income
Recognized
 
Residential Owner Occupied $6,177  $317  $313  $3,954  $244  $237 
Residential Non Owner Occupied  3,920   143   143   3,133   211   210 
Total 1-4 Family Residential Real Estate  10,097   460   456   7,087   455   447 
Multi-Family Residential Real Estate  903   4   4   3,946   124   123 
CRE Owner Occupied  8,906   145   142   6,925   203   183 
CRE Non Owner Occupied  18,164   807   809   5,351   411   407 
Agriculture Land  611   14   14   2,283   128   68 
Other CRE  1,694   20   22   1,632   71   70 
Total Commercial Real Estate  29,375   986   987   16,191   813   728 
Construction  233   12   15   -   -   - 
Commercial Working Capital  2,790   29   29   1,606   109   90 
Commercial Other  4,576   14   12   2,393   81   79 
Total Commercial  7,366   43   41   3,999   190   169 
Home Equity and Home Improvement  2,233   95   94   1,543   85   83 
Consumer Finance  47   3   3   67   8   8 
Total Impaired Loans $50,254  $1,603  $1,600  $32,833  $1,675  $1,558 

 

 - 8994 - 

 

 

The following table presents loans individually evaluated for impairment by class of loans (In Thousands):

 

 December 31, 2016 December 31, 2015  December 31, 2018  December 31, 2017 
 Unpaid
Principal
Balance*
  Recorded
Investment
  Allowance
for Loan
Losses
Allocated
  Unpaid
Principal
Balance*
  Recorded
Investment
  Allowance
for Loan
Losses
Allocated
  

 

Unpaid
Principal
Balance*

  Recorded
Investment
  Allowance
for Loan
Losses
Allocated
  

 

Unpaid
Principal
Balance*

  Recorded
Investment
  Allowance
for Loan
Losses
Allocated
 
With no allowance recorded:                                                
Residential Owner Occupied $1,912  $1,765  $-  $1,383  $1,360  $-  $901  $775  $-  $2,507  $2,364  $- 
Residential Non Owner Occupied  1,691   1,683   -   2,147   2,141   -   950   955   -   1,711   1,708   - 
Total 1-4 Family Residential Real Estate  3,603   3,448   -   3,530   3,501   -   1,851   1,730   -   4,218   4,072   - 
Multi-Family Residential Real Estate  3,578   3,430   -   3,463   3,313   -   1,296   1,302   -   2,095   2,102   - 
CRE Owner Occupied  2,652   2,353   -   4,869   4,520   -   7,464   6,202   -   12,273   11,804   - 
CRE Non Owner Occupied  4,372   4,240   -   7,932   7,685   -   1,824   1,659   -   3,085   2,925   - 
Agriculture Land  1,695   1,722   -   3,546   3,596   -   14,915   14,994   -   13,029   13,185   - 
Other CRE  1,225   1,115   -   4,076   4,046   -   464   462   -   981   768   - 
Total Commercial Real Estate  9,944   9,430   -   20,423   19,847   -   24,667   23,317   -   29,368   28,682   - 
Construction  -   -   -   -   -   -   -   -   -   -   -   - 
Commercial Working Capital  838   786   -   1,644   1,648   -   7,569   7,498   -   5,462   5,422   - 
Commercial Other  1,179   967   -   3,573   3,607   -   2,095   2,100   -   9,916   7,644   - 
Total Commercial  2,017   1,753   -   5,217   5,255   -   9,664   9,598   -   15,378   13,066   - 
Home Equity and Home Improvement  631   585   -   817   772   -   -   -   -   630   584   - 
Consumer Finance  55   55   -   60   59   -   -   -   -   42   42   - 
Total loans with no allowance recorded $19,828  $18,701  $-  $33,510  $32,747  $-  $37,478  $35,947  $-  $51,731  $48,548  $- 
                                                
With an allowance recorded:                                                
Residential Owner Occupied $2,348  $2,319  $157  $2,918  $2,837  $188  $3,926  $3,884  $148  $1,841  $1,814  $137 
Residential Non Owner Occupied  1,137   1,131   45   1,231   1,236   13   1,152   1,160   27   1,031   1,024   30 
Total 1-4 Family Residential Real Estate  3,485   3,450   202   4,149   4,073   201   5,078   5,044   175   2,872   2,838   167 
Multi-Family Residential Real Estate  53   53   4   -   -   -   44   44   3   175   176   7 
CRE Owner Occupied  2,362   1,894   102   3,250   2,767   132   2,419   1,935   38   2,007   1,546   44 
CRE Non Owner Occupied  1,618   1,479   108   385   308   2   350   353   16   651   593   28 
Agriculture Land  45   45   3   68   69   2   37   38   2   293   292   14 
Other CRE  1,144   722   42   926   502   3   1,107   691   39   909   708   32 
Total Commercial Real Estate  5,169   4,140   255   4,629   3,646   139   3,913   3,017   95   3,860   3,139   118 
Construction  -   -   -   -   -   -   -   -   -   -   -   - 
Commercial Working Capital  230   231   24   594   596   62   525   528   55   447   449   77 
Commercial Other  167   170   11   252   256   1   560   352   24   854   858   110 
Total Commercial  397   401   35   846   852   63   1,085   880   79   1,301   1,307   187 
Home Equity and Home Improvement  688   684   313   724   719   34   1,013   963   242   596   592   279 
Consumer Finance  4   4   -   12   12   -   45   45   1   8   8   - 
Total loans with an allowance recorded $9,796  $8,732  $809  $10,360  $9,302  $437  $11,178  $9,993  $595  $8,812  $8,060  $758 

 

* Presented gross of charge offs

 

 - 9095 - 

 

 

The following table presents the current balance of the aggregate amounts of non-performing assets, comprised of non-performing loans and real estate owned on the dates indicated:

 

 December 31,
2016
  December 31,
2015
  December 31,
2018
  December 31,
2017
 
 (In Thousands)  (In Thousands) 
Non-accrual loans $14,348  $16,261  $19,016  $30,715 
Loans over 90 days past due and still accruing  -   -   -   - 
Total non-performing loans  14,348   16,261   19,016   30,715 
Real estate and other assets held for sale  455   1,321   1,205   1,532 
Total non-performing assets $14,803  $17,582  $20,221  $32,247 
        
Troubled debt restructuring, still accruing $10,544  $11,178  $11,573  $13,770 

 

The following table presents the aging of the recorded investment in past due and non-accrual loans as of December 31, 20162018, by class of loansloans: (In Thousands):

 

 Current  30-59 days  60-89 days  90+ days  Total Past
Due
  Total Non
Accrual
 
              Current  30-59 days  60-89 days  90+ days  Total
Past Due
  Total Non
Accrual
 
Residential Owner Occupied $139,015  $56  $842  $544  $1,442  $1,931  $199,664  $887  $821  $1,402  $3,110  $3,266 
Residential Non Owner Occupied  66,811   166   308   63   537   992   119,988   64   180   165   409   363 
                        
Total 1-4 Family Residential Real Estate  205,826   222   1,150   607   1,979   2,923   319,652   951   1,001   1,567   3,519   3,629 
                        
Multi-Family Residential Real Estate  197,197   -   -   -   -   2,637   278,748   -   -   -   -   102 
                                                
CRE Owner Occupied  340,233   79   -   1,396   1,475   3,098   416,879   52   300   138   490   4,377 
CRE Non Owner Occupied  338,724   81   16   426   523   1,808   534,823   6   119   -   125   620 
Agriculture Land  102,397   -   -   -   -   755   129,040   66   -   2,869   2,935   5,253 
Other Commercial Real Estate  62,415   -   -   249   249   1,292   45,232   11   -   -   11   - 
                                                
Total Commercial Real Estate  843,769   160   16   2,071   2,247   6,953   1,125,974   135   419   3,007   3,561   10,250 
                                                
Construction  89,244   -   -   -   -   -   142,096   -   -   -   -   - 
                                                
Commercial Working Capital  202,786   -   10   38   48   435   217,832   268   -   3,838   4,106   4,021 
Commercial Other  267,189   23   -   365   388   577   289,125   32   54   235   321   480 
                                                
Total Commercial  469,975   23   10   403   436   1,012   506,957   300   54   4,073   4,427   4,501 
                                                
Home Equity and Home Improvement  117,458   1,125   176   254   1,555   730   127,346   1,446   146   90   1,682   394 
Consumer Finance  16,452   85   69   78   232   91   34,224   134   77   96   307   126 
                                                
Total Loans $1,939,921  $1,615  $1,421  $3,413  $6,449  $14,346  $2,534,997  $2,966  $1,697  $8,833  $13,496  $19,002 

 

 - 9196 - 

 

 

The following table presents the aging of the recorded investment in past due and non-accrual loans as of December 31, 20152017, by class of loans:loans (In Thousands):

 

 Current  30-59 days  60-89 days  90+ days  Total
Past Due
  Total Non
Accrual
 
              Current  30-59 days  60-89 days  90+ days  Total
Past Due
  Total Non
Accrual
 
Residential Owner Occupied $138,974  $159  $673  $391  $1,223  $1,428  $175,139  $821  $1,033  $1,227  $3,081  $2,510 
Residential Non Owner Occupied  64,577   324   356   226   906   1,179   96,400   495   8   233   736   520 
                        
Total 1-4 Family Residential Real Estate  203,551   483   1,029   617   2,129   2,607   271,539   1,316   1,041   1,460   3,817   3,030 
                        
Multi-Family Residential Real Estate  165,671   -   -   2,024   2,024   2,417   247,980   422   -   -   422   128 
                                                
CRE Owner Occupied  322,940   772   1,218   1,266   3,256   4,141   393,125   195   188   1,268   1,651   10,775 
CRE Non Owner Occupied  304,166   -   106   538   644   1,229   403,656   1   91   424   516   2,431 
Agriculture Land  98,055   57   -   -   57   695   131,753   412   -   66   478   4,144 
Other Commercial Real Estate  53,494   -   -   315   315   1,364   58,784   13   -   204   217   734 
                                                
Total Commercial Real Estate  778,655   829   1,324   2,119   4,272   7,429   987,318   621   279   1,962   2,862   18,084 
                                                
Construction  96,845   -   -   -   -   -   149,174   -   -   -   -   - 
                                   ��            
Commercial Working Capital  168,938   16   -   154   170   251   233,632   102   1,264   876   2,242   2,369 
Commercial Other  249,070   203   46   2,223   2,472   2,833   291,455   82   -   517   599   6,474 
                                                
Total Commercial  418,008   219   46   2,377   2,642   3,084   525,087   184   1,264   1,393   2,841   8,843 
                                                
Home Equity and Home Improvement  116,599   733   92   44   869   689   133,144   2,490   434   206   3,130   591 
Consumer Finance  16,216   27   3   24   54   36   28,800   293   80   2   375   27 
                                                
Total Loans $1,795,545  $2,291  $2,494  $7,205  $11,990  $16,262  $2,343,042  $5,326  $3,098  $5,023  $13,447  $30,703 

 

Troubled Debt Restructurings

 

As of December 31, 20162018 and 2015,2017, the Company had a recorded investment in troubled debt restructurings (“TDRs”) of $16.8$19.2 million and $17.6$21.7 million, respectively. The Company allocated $809,000$581,000 and $335,000,$751,000, of specific reserves to those loans at December 31, 20162018 and 2015,2017, and committed to lend additional amounts totaling up to $20,000$169,000 and $48,000$242,000 at December 31, 20162018 and 2015.2017.

 

The Company offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Each TDR is uniquely designed to meet the specific needs of the borrower. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral or an additional guarantor is often requested when granting a concession. Commercial mortgagereal estate loans modified in a TDR often involve temporary interest-only payments, re-amortization of remaining debt in order to lower payments, and sometimes reducing the interest rate lower than the current market rate. Residential mortgage loans modified in a TDR are comprised of loans where monthly payments are lowered, either through interest rate reductions or principal only payments for a period of time, to accommodate the borrowers’ financial needs, interest is capitalized into principal, or the term and amortization are extended. Home equity modifications are made infrequently and usually involve providing an interest rate that is lower than the borrower would be able to obtain due to credit issues. All retail loans where the borrower is in bankruptcy are classified as TDRs regardless of whether or not a concession is made.

 

 - 9297 - 

 

 

Of the loans modified in a TDR, $6.2$7.6 million are on non-accrual status and partial charge-offs have in some cases been taken against the outstanding balance. Loans modified as a TDR may have the financial effect of increasing the allowance associated with the loan. If the loan is determined to be collateral dependent, the estimated fair value of the collateral, less any selling costs is used to determine if there is a need for a specific allowance or charge-off. If the loan is determined to be cash flow dependent, the allowance is measured based on the present value of expected future cash flows discounted at the loan’s pre-modification effective interest rate.

 

The following table presents loans by class modified as TDRs that occurred during the years indicated (Dollars in Thousands):

 

 Loans Modified as a TDR for the
Twelve Months Ended
December 31, 2016
  Loans Modified as a TDR for the
Twelve Months Ended
December 31, 2015
  Loans Modified as a TDR for the
Twelve Months Ended
December 31, 2014
  Loans Modified as a TDR for the
Twelve Months Ended  
December 31, 2018
 Loans Modified as a TDR for the
Twelve Months Ended  
December 31, 2017
 Loans Modified as a TDR for the
Twelve Months Ended  
December 31, 2016
 
TDRs Number of
Loans
  Recorded
Investment (as of
period end)
  Number of
Loans
  Recorded
Investment (as
of period end)
  Number of
Loans
  Recorded
Investment (as of
period end)
  Number
of Loans
 Recorded
Investment (as of
period end)
 Number
of Loans
 Recorded
Investment (as
of period end)
 Number of
Loans
 Recorded
Investment (as of
period end)
 
             
Residential Owner Occupied  17  $778   6  $454   18  $1,726   18  $980   24  $982   17  $778 
Residential Non Owner Occupied  5   494   4   59   3   517   4   189   5   193   5   494 
Multi Family  2   1,885   -   -   -   -   -   -   -   -   2   1,885 
CRE Owner Occupied  -   -   2   645   2   27   12   1,639   2   149   -   - 
CRE Non Owner Occupied  5   974   2   244   3   403   1   42   1   262   5   974 
Agriculture Land  1   45   3   1,443   -   -   -   -   5   1,700   1   45 
Other CRE  1   348   -   -   -   -   -   -   2   153   1   348 
Commercial Working Capital  1   226   2   62   4   1,353   5   2,898   7   1,475   1   226 
Commercial Other  1   587   2   70   16   2,020   1   44   7   3,833   1   587 
Home Equity and Home Improvement  9   281   13   324   17   471   7   89   6   152   9   281 
Consumer Finance  2   14   9   62   4   15   8   29   5   14   2   14 
                        
Total  44  $5,632   43  $3,363   67  $6,532   56  $5,910   64  $8,913   44  $5,632 

 

The loans described above increased the allowance for loan losses (“ALLL”) by $110,000 for the year ended December 31, 2018, decreased the ALLL by $104,000 for the year ended December 31, 2017, and increased the ALLL by $413,000 for the year ended December 31, 2016, decreased the ALLL by $13,000 for the year ended December 31, 2015, and increased the ALLL by $234,000 for the year ended December 31, 2014.2016.

 

Of the 20162018 modifications, fifteenfour were made TDRsa TDR due to the fact that the borrower filed bankruptcy,terming out lines of credit, 18 were made a TDR due to advancing or renewing money to a watch list credit, one loan was made a TDR due to ana reduction of the interest only period, sixrate, five were made a TDR due to extending the maturity, five18 were made TDRsa TDR due to advancing or renewing funds to a watchlist credit, twobankruptcy and 10 were made TDRsa TDR because the current debt was refinanced due to term out lines of credit, and fifteen were made TDRs to refinance current debtmaturity or for payment relief.

 

 - 9398 - 

 

 

The following table presents loans by class modified as TDRs for which there was a payment default within twelve months following the modification during the indicated:

 

 Twelve Months Ended
December 31, 2016
($ in thousands)
  Twelve Months Ended
December 31, 2015
($ in thousands)
  Twelve Months Ended
December 31, 2014
($ in thousands)
  Twelve Months Ended
December 31, 2018
 ($ in thousands)
  Twelve Months Ended
December 31, 2017
 ($ in thousands)
  Twelve Months Ended
December 31, 2016
 ($ in thousands)
 
TDRs
That Subsequently Defaulted:
 Number of
Loans
  Recorded
Investment
(as of Period
End)
  Number of
Loans
  Recorded
Investment
(as of Period
End)
  Number of
Loans
  Recorded
Investment
(as of Period
End)
  Number of
Loans
  Recorded
Investment
(as of Period
End)
  Number of
Loans
  Recorded
Investment
(as of Period
End)
  Number
of Loans
  Recorded
Investment
(as of Period
End)
 
             
Residential Owner Occupied  -  $-   -  $-   1  $80   1  $76   -  $-   -  $- 
Residential Non Owner Occupied  -   -   -   -   1   178   1   45   -   -   -   - 
CRE Owner Occupied  -   -   -   -   -   -   -   -   -   -   -   - 
CRE Non Owner Occupied  1   205   -   -   -   -   -   -   -   -   1   205 
Agriculture Land  -   -   -   -   -   -   -   -   -   -   -   - 
Other CRE  -   -   -   -   -   -   -   -   -   -   -   - 
Commercial Working Capital  -   -   1   120   2   868   3   2,644   -   -   -   - 
Commercial Other  -   -   5   1,791   5   865   1   30   -   -   -   - 
Home Equity and Home Improvement  -   -   1   22   -   -   1   61   -   -   -   - 
Consumer  -   -   -   -   -   -   -   -   -   -   -   - 
                        
Total  1  $205   7  $1,933   9  $1,991   7  $2,856   -  $-   1  $205 

 

The TDRs that subsequently defaulted described above increased the ALLL by $17,000 for the year ended December 31, 2018, and had no effect on the ALLL for the yearyears ended December 31, 20162017 and 2015. They decreased the ALLL by $14,000 after $176,000 in charge-offs for the year ended December 31, 2014.2016.

 

A default for purposes of this disclosure is a TDR loan in which the borrower is 90 days contractually past due under the modified terms.

The terms of certain other loans were modified during the periods ending December 31, 2016 and 2015 that did not meet the definition of a TDR. The modification of these loans involved a modification of the terms of a loan to borrowers who were not experiencing financial difficulties. A total of 373 loans were modified under this definition during the twelve month period ended December 31, 2016 and a total of 187 loans were modified under this definition during the twelve month period ended December 31, 2015.

 

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed regarding the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.

 

Credit Quality Indicators

 

Loans are categorized into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are analyzed individually by classifying the loans as to credit risk. This analysis includes all non-homogeneous loans, such as commercial and commercial real estate loans and certain homogenous mortgage, home equity and consumer loans. This analysis is performed on a quarterly basis. First Defiance uses the following definitions for risk ratings:

 

Special Mention.Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

 

- 94 -

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

- 99 -

Doubtful.Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Not Graded.Loans classified as not graded are generally smaller balance residential real estate, home equity and consumer installment loans which are originated primarily by using an automated underwriting system. These loans are monitored based on their delinquency status and are evaluated individually only if they are seriously delinquent.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of December 31, 2016,2018, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (In Thousands):

 

Class Pass  Special
Mention
  Substandard  Doubtful  Not
Graded
  Total  Pass  Special
Mention
  Substandard  Doubtful  Not
Graded
  Total 
             
Residential Owner Occupied $5,980  $402  $1,824  $-  $132,250  $140,456  $9,419  $91  $3,130  $-  $190,134  $202,774 
Residential Non Owner Occupied  58,041   1,394   3,480   -   4,434   67,349   109,885   700   3,087   -   6,725   120,397 
                        
Total 1-4 Family Real Estate  64,021   1,796   5,304   -   136,684   207,805   119,304   791   6,217   -   196,859   323,171 
                        
Multi-Family Residential Real Estate  192,369   862   3,852   -   114   197,197   276,594   -   2,047   -   107   278,748 
                                                
CRE Owner Occupied  316,335   20,559   4,430   -   384   341,708   402,008   5,724   9,547   -   89   417,368 
CRE Non Owner Occupied  332,196   1,617   5,435   -   -   339,248   529,842   2,807   2,297   -   -   534,946 
Agriculture Land  98,039   2,355   2,002   -   -   102,396   111,595   4,023   16,358   -   -   131,976 
Other CRE  59,561   60   2,297   -   746   62,664   42,189   730   1,244   -   1,082   45,245 
                                                
Total Commercial Real Estate  806,131   24,591   14,164   -   1,130   846,016   1,085,634   13,284   29,446   -   1,171   1,129,535 
                                                
Construction  67,751   706   -   -   20,787   89,244   122,775   219   -   -   19,102   142,096 
                                                
Commercial Working Capital  193,043   8,301   1,490   -   -   202,834   205,903   6,546   9,489   -   -   221,938 
Commercial Other  262,076   3,749   1,752   -   -   267,577   279,234   7,011   3,201   -   -   289,446 
                                                
Total Commercial  455,119   12,050   3,242   -   -   470,411   485,137   13,557   12,690   -   -   511,384 
                                                
Home Equity and Home Improvement  -   -   696   -   118,317   119,013   -   -   434   -   128,594   129,028 
Consumer Finance  -   -   90   -   16,594   16,684   -   -   206   -   34,325   34,531 
                                                
Total Loans $1,585,391  $40,005  $27,348  $-  $293,626  $1,946,370  $2,089,444  $27,851  $51,040  $-  $380,158  $2,548,493 

 

 - 95100 - 

 

 

As of December 31, 2015,2017, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (In Thousands):

 

Class Pass  Special
Mention
  Substandard  Doubtful  Not
Graded
  Total  Pass  Special
Mention
  Substandard  Doubtful  Not
Graded
  Total 
             
Residential Owner Occupied $5,828  $123  $2,427  $-  $131,820  $140,198  $7,534  $99  $2,367  $-  $168,220  $178,220 
Residential Non Owner Occupied  55,169   1,420   4,439   -   4,454   65,482   85,802   935   3,835   -   6,564   97,136 
                        
Total 1-4 Family Real Estate  60,997   1,543   6,866   -   136,274   205,680   93,336   1,034   6,202   -   174,784   275,356 
                        
Multi-Family Residential Real Estate  163,405   498   3,675   -   117   167,695   242,969   2,503   2,819   -   111   248,402 
                                                
CRE Owner Occupied  297,856   17,896   9,730   -   714   326,196   370,613   10,432   13,575   -   156   394,776 
CRE Non Owner Occupied  293,057   2,143   9,595   -   15   304,810   395,264   3,464   5,444   -   -   404,172 
Agriculture Land  92,262   1,947   3,903   -   -   98,112   114,776   2,639   14,816   -   -   132,231 
Other CRE  47,109   469   5,739   -   492   53,809   56,133   165   1,788   -   915   59,001 
                                                
Total Commercial Real Estate  730,284   22,455   28,967   -   1,221   782,927   936,786   16,700   35,623   -   1,071   990,180 
                                                
Construction  76,152   2,159   -   -   18,534   96,845   125,519   1,254   -   -   22,401   149,174 
                                                
Commercial Working Capital  163,071   2,497   3,540   -   -   169,108   222,526   7,605   5,743   -   -   235,874 
Commercial Other  243,308   2,706   5,528   -   -   251,542   280,013   3,443   8,598   -   -   292,054 
                                                
Total Commercial  406,379   5,203   9,068   -   -   420,650   502,539   11,048   14,341   -   -   527,928 
                                                
Home Equity and Home Improvement  -   -   689   -   116,779   117,468   -   -   600   -   135,674   136,274 
Consumer Finance  -   -   15   -   16,255   16,270   -   -   82   -   29,093   29,175 
                                                
Total Loans $1,437,217  $31,858  $49,280  $-  $289,180  $1,807,535  $1,901,149  $32,539  $59,667  $-  $363,134  $2,356,489 

 

 - 96101 - 

 

 

Certain loans acquired had evidence that the credit quality of the loan had deteriorated since its origination and in management’s assessment at the acquisition date it was probable that First Defiance would be unable to collect all contractually required payments due. In accordance with FASB ASC Topic 310 Subtopic 30,Loans and Debt Securities Acquired with Deteriorated Credit Quality, these loans have been recorded based on management’s estimate of the fair value of the loans. DetailsThe outstanding balance of thesethose loans areby segment is as follows (In thousands):

  December 31, 2018  December 31, 2017 
1-4 Family Residential Real Estate $1,045  $1,154 
Multi-Family Residential Real Estate  300   309 
Commercial Real Estate Loans  899   2,921 
Commercial  227   407 
Consumer  -   2 
Total Outstanding Balance $2,471  $4,793 
Recorded Investment, net of allowance of $0 $2,331  $3,828 

Accretable yield, or income expected to be collected, is as follows:

 

  Contractual
Amount
Receivable
  Impairment
Discount
  Recorded
Loan
Receivable
 
  (In Thousands) 
Balance at January 1, 2014 $503  $273  $230 
Principal payments received  (90)  -   (90)
Loans charged off  -   -   - 
Additional provision for loan loss  -   -   - 
Loan accretion recorded  -   (46)  46 
Balance at December 31, 2014  413   227   186 
Principal payments received  (51)  -   (51)
Loans charged off  -   -   - 
Additional provision for loan loss  -   -   - 
Loan accretion recorded  -   (34)  34 
Balance at December 31, 2015  362   193   169 
Principal payments received  (261)  -   (261)
Loans charged off  (35)  (35)  - 
Additional provision for loan loss  -   -   - 
Loan accretion recorded  -   (103)  103 
Balance at December 31, 2016 $66  $55  $11 
  2018  2017 
Balance at January 1 $804  $- 
         
New Loans Purchased  -   1,018 
Accretion of Income  (139)  (163)
Reclassification from Non-accretable  -   - 
Charge-off of Accretable Yield  (197)  (8)
Balance at December 31 $468  $847 

For those purchased loans disclosed above, the Company did not increase the allowance for loan losses during the twelve months ended December 31, 2018 or 2017. No allowances for loan losses were reversed during the same period.

Contractually required payments receivable of loans purchased with evidence of credit deterioration during the period ended December 31, 2017, using information as of the date of acquisition are included in the table below. There were no such loans purchased during the year ended December 31, 2018. (In Thousands)

1-4 Family Residential Real Estate $1,720 
Commercial Real Estate  4,724 
Commercial  785 
Consumer  4 
Total $7,233 

Cash Flows Expected to be Collected at Acquisition $ 5,721

Fair Value of Acquired Loans at Acquisition $ 4,703

- 102 -

 

Loans to executive officers, directors, and their affiliates are as follows:

 

 Years Ended December 31  Years Ended December 31, 
 2016  2015  2018  2017 
 (In Thousands)  (In Thousands) 
Beginning balance $7,349  $5,888  $16,728  $16,199 
New loans  4,783   5,822   10,806   5,857 
Effect of changes in composition of related parties  12,320   (54)  (217)  - 
Repayments  (8,253)  (4,307)  (5,754)  (5,328)
Ending Balance $16,199  $7,349  $21,563  $16,728 

 

- 97 -

Foreclosure Proceedings

 

Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $796,000 as of December 31, 2018.

 

8. Mortgage Banking

 

Net revenues from the sales and servicing of mortgage loans consisted of the following:

 

 Years Ended December 31  Years Ended December 31, 
 2016  2015  2014  2018  2017  2016 
 (In Thousands)  (In Thousands) 
Gain from sale of mortgage loans $5,311  $4,564  $3,335  $4,502  $4,664  $5,311 
Mortgage loan servicing revenue (expense):                        
Mortgage loan servicing revenue  3,560   3,503   3,552   3,784   3,714   3,560 
Amortization of mortgage servicing rights  (1,724)  (1,620)  (1,401)  (1,341)  (1,464)  (1,724)
Mortgage servicing rights valuation adjustments  123   266   116   132   90   123 
  1,959   2,149   2,267   2,575   2,340   1,959 
            
Net mortgage banking income $7,270  $6,713  $5,602  $7,077  $7,004  $7,270 

 

The unpaid principal balance of residential mortgage loans serviced for third parties was $1.37$1.41 billion at December 31, 20162018, and $1.34$1.39 billion at December 31, 2015.2017.

 

Activity for capitalized mortgage servicing rights (“MSRs”) and the related valuation allowance is as follows:

 

 Years Ended December 31  Years Ended December 31, 
 2016  2015  2014  2018  2017  2016 
 (In Thousands)  (In Thousands) 
Mortgage servicing assets:                        
Balance at beginning of period $9,893  $9,923  $10,133  $10,240  $10,117  $9,893 
Loans sold, servicing retained  1,948   1,590   1,191   1,520   1,587   1,948 
Amortization  (1,724)  (1,620)  (1,401)  (1,341)  (1,464)  (1,724)
Carrying value before valuation allowance at end of period  10,117   9,893   9,923   10,419   10,240   10,117 
                        
Valuation allowance:                        
Balance at beginning of period  (645)  (911)  (1,027)  (432)  (522)  (645)
Impairment recovery (charges)  123   266   116   132   90   123 
Balance at end of period  (522)  (645)  (911)  (300)  (432)  (522)
Net carrying value of MSRs at end of period $9,595  $9,248  $9,012  $10,119  $9,808  $9,595 
Fair value of MSRs at end of period $9,770  $9,802  $9,304  $10,656  $9,930  $9,770 

- 103 -

 

Amortization of mortgage servicing rights is computed based on payments and payoffs of the related mortgage loans serviced.

 

The Company had no actual losses from secondary market buy-backs in 2018, 2017 or 2016. Based on management’s estimate of potential losses from secondary market buyback activity, a liability of $79,000 and $214,000$43,000 was accrued at both December 31, 20162018 and 2015, respectively,2017, and is reflected in other liabilities in the Consolidated Statements of Financial Condition. Expense (credit) recognized related to the accrual was $(135,000), $(95,000)$0, $(36,000) and $298,000$(135,000) for the years ended December 31, 2018, 2017 and 2016, 2015 and 2014, respectively.

- 98 -

 

The Company’s servicing portfolio is comprised of the following:

 

 December 31  December 31, 
 2016  2015  2018  2017 
 Number of Principal Number of Principal  Number of Principal Number of Principal 
Investor Loans  Outstanding  Loans  Outstanding  Loans  Outstanding  Loans  Outstanding 
 (In Thousands)  (In Thousands) 
Fannie Mae  5,004  $470,692   5,104  $484,155   4,919  $461,730   4,920  $461,783 
Freddie Mac  9,229   889,280   9,015   845,564   9,571   937,406   9,420   913,632 
Federal Home Loan Bank  101   11,081   118   12,605   99   11,983   88   9,723 
Other  16   965   21   1,398   17   714   19   930 
Totals  14,350  $1,372,018   14,258  $1,343,722   14,606  $1,411,833   14,447  $1,386,068 

 

Custodial escrow balances maintained in connection with serviced loans were $12.6$14.3 million and $11.6$13.5 million at December 31, 20162018 and 2015,2017, respectively.

 

Significant assumptions at December 31, 20162018, used in determining the value of MSRs include a weighted average prepayment speed assumption (“PSA”) of 152131 and a weighted average discount rate of 12.01%. Significant assumptions at December 31, 20152017, used in determining the value of MSRs include a weighted average prepayment rate of 181151 PSA and a weighted average discount rate of 10.02%12.01%.

 

A sensitivity analysis of the current fair value to immediate 10% and 20% adverse changes in those assumptions as of December 31, 20162018, is presented below. These sensitivities are hypothetical. Changes in fair value based on 10% and 20% variation in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the MSR is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, changes in mortgage interest rates, which drive changes in prepayment rate estimates, could result in changes in the discount rates), which might magnify or counteract the sensitivities.

 

 10% Adverse 20% Adverse  10% Adverse 20% Adverse 
 Change  Change  Change  Change 
 (In Thousands)  (In Thousands) 
Assumption:                
Decline in fair value from increase in prepayment rate $243  $475  $332  $670 
Decline in fair value from increase in discount rate  311   612   220   459 

 

 - 99104 - 

 

 

9. Premises and Equipment

 

Premises and equipment are summarized as follows:

 

 December 31  December 31, 
 2016  2015  2018  2017 
 (In Thousands)  (In Thousands) 
Cost:                
Land $7,534  $7,494  $7,977  $7,977 
Land improvements  1,310   1,310   1,326   1,326 
Buildings  41,895   41,556   44,632   44,563 
Leasehold improvements  971   971   1,015   971 
Furniture, fixtures and equipment  31,253   29,622   34,871   34,216 
Construction in process  787   656   692   1,402 
  83,750   81,609   90,513   90,455 
Less allowances for depreciation and amortization  (46,792)  (43,443)  (49,843)  (50,238)
 $36,958  $38,166  $40,670  $40,217 

 

Depreciation expense was $3.4$3.7 million, $3.3$3.6 million and $3.0$3.4 million for the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively.

 

Lease Agreements

 

The Company has entered into lease agreements covering sixnine First Insurance Group offices, twofive banking center locations, one loan production office, two land leases for which the Company owns the banking centers, one land lease which is primarily used for parking, one land lease that is to be terminated in the first quarter of 2017for future branch development and numerous stand-alone Automated Teller Machine sites with varying terms and options to renew. First Federal and First Insurance share office space for one lease as a branch and insurance office.

 

Future minimum commitments under non-cancelable operating leases are as follows (In Thousands):

 

2017 $584 
2018  400 
2019  337  $967 
2020  265   884 
2021  222   843 
2022  768 
2023  739 
Thereafter  2,654   8,078 
Total $4,462  $12,279 

 

Rental expenses under operating leases amounted to $1.0 million, $691,000 and $571,000 $601,000in 2018, 2017, and $653,000 in 2016, 2015, and 2014, respectively.

 

 - 100105 - 

 

 

10. Goodwill and Intangible Assets

 

Goodwill

 

The change in the carrying amount of goodwill for the year is as follows:

 

 December 31  December 31, 
 2016  2015  2018  2017 
 (In Thousands)  (In Thousands) 
Beginning balance $61,798  $61,525  $98,569  $61,798 
Goodwill acquired or adjusted during the year  -   273   -   36,771 
Ending balance $61,798  $61,798  $98,569  $98,569 

 

Acquired Intangible Assets

 

Activity in intangible assets for the years ended December 31, 2016, 20152018, 2017 and 20142016, was as follows:

 Gross       Gross      
 Carrying Accumulated Net  Carrying Accumulated Net 
 Amount  Amortization  Value  Amount  Amortization  Value 
 (In Thousands)  (In Thousands) 
Balance as of January 1, 2014 $14,302  $(10,805) $3,497 
Balance as of January 1, 2016 $14,477  $(12,606) $1,871 
Amortization of intangible assets  -   (1,102)  (1,102)  -   (535)  (535)
Balance as of December 31, 2014  14,302   (11,907)  2,395 
Balance as of December 31, 2016  14,477   (13,141)  1,336 
Intangible assets acquired  175   -   175   5,656   -   5,656 
Amortization of intangible assets  -   (699)  (699)  -   (1,289)  (1,289)
Balance as of December 31, 2015  14,477   (12,606)  1,871 
Balance as of December 31, 2017  20,133   (14,430)  5,703 
Amortization of intangible assets  -   (535)  (535)  -   (1,312)  (1,312)
Balance as of December 31, 2016 $14,477  $(13,141) $1,336 
Balance as of December 31, 2018 $20,133  $(15,742) $4,391 

 

Estimated amortization expense for each of the next five years and thereafter is as follows (In Thousands):

 

2017 $404 
2018  332 
2019  225  $1,097 
2020  149   914 
2021  87   744 
2022  576 
2023  439 
Thereafter  139   621 
Total $1,336  $4,391 

 

11. Deposits

 

The following schedule sets forth interest expense by type of deposit:

 

  Years Ended December 31 
  2016  2015  2014 
  (In Thousands) 
Checking and money market accounts $1,463  $1,186  $1,236 
Savings accounts  88   89   90 
Certificates of deposit  4,710   4,066   3,957 
Totals $6,261  $5,341  $5,283 

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  Years Ended December 31, 
  2018  2017  2016 
  (In Thousands) 
Checking and money market accounts $3,997  $2,033  $1,463 
Savings accounts  115   102   88 
Certificates of deposit  9,785   6,683   4,710 
Totals $13,897  $8,818  $6,261 

 

Accrued interest payable on deposit accounts amounted to $42,000$366,000 and $43,000$97,000 at December 31, 20162018 and 2015,2017, respectively, which was comprised of $19,000$314,000 and $23,000$52,000 for certificates of deposit and checking and money market accounts, respectively, at December 31, 20162018, and $25,000$68,000 and $18,000$29,000 for certificates of deposit and checking and money market accounts, respectively, at December 31, 2015.2017.

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A summary of deposit balances is as follows:

 

 December 31  December 31, 
 2016  2015  2018  2017 
 (In Thousands)  (In Thousands) 
Non-interest bearing checking accounts $487,663  $420,691 
Interest bearing checking and money market accounts  816,665   767,201 
Noninterest-bearing checking accounts $607,198  $571,360 
Interest-bearing checking and money market accounts  1,040,471   1,005,519 
Savings deposits  243,369   219,655   292,829   302,022 
Retail certificates of deposit less than $250,000  400,080   403,902   591,822   504,912 
Retail certificates of deposit greater than $250,000  33,851   24,688   88,562   53,843 
 $1,981,628  $1,836,137  $2,620,882  $2,437,656 

 

Scheduled maturities of certificates of deposit at December 31, 20162018, are as follows (In Thousands):

 

2017 $156,767 
2018  117,627 
2019  78,750  $417,562 
2020  35,298   130,756 
2021  45,489   85,563 
2022  33,184 
2023  13,319 
Thereafter  -   - 
Total $433,931  $680,384 

 

12. Advances from Federal Home Loan Bank

 

First Federal has the ability to borrow funds from the FHLB. First Federal pledges its single-family residential mortgage loan portfolio, certain investment securities; certain first mortgage home equity loans, certain commercial real estate loans, and certain agriculture real estate loans as security for these advances. Advances secured by investment securities must have collateral of at least 105% of the borrowing. Advances secured by residential mortgages must have collateral of at least 125% of the borrowings. Advances secured by commercial real estate loans, and agriculture real estate loans must have collateral of at least 300% of the borrowings. The total level of borrowing is also limited to 50% of total assets and at least 50% of the borrowings must be secured by either one-to-four family residential mortgages or investment securities. Total loans pledged to the FHLB at December 31, 20162018, and December 31, 20152017, were $843.8 million$1.2 billion and $692.2 million,$1.0 billion, respectively. First Federal could obtain advances of up to approximately $448.9$447.4 million from the FHLB at December 31, 2016.2018.

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At year-end, advances from the FHLB were as follows:

 

Principal Terms Advance
Amount
  Range of Maturities  

Weighted
Average

Interest
Rate

  

Advance
Amount

  Range of Maturities Weighted
Average
Interest
Rate
 
(In Thousands)
December 31, 2016          
 (In Thousands)  
December 31, 2018        
Single maturity fixed rate advances  59,000  January 2019 to March 2022  1.67%
Amortizable mortgage advances  1,213  August 2027  2.14%
Overnight advances  25,000  Overnight  2.45%
Fair value adj. on acquired balances  (24)      
 $85,189       
          
December 31, 2017          
Putable advances $5,000   March 2018   2.35% $5,000  March 2018  2.35%
Single maturity fixed rate advances  92,000   November 2017 to March 2022   1.34%  72,000  January 2018 to March 2022  1.46%
Amortizable mortgage advances  6,943   September 2018   1.78%  7,306  September 2018 to August 2027  1.85%
Fair value adj. on acquired balances  (27)      
 $103,943        $84,279       
          
December 31, 2015          
Putable advances $5,000   March 2018   2.35%
Single maturity fixed rate advances  47,000   December 2017 to March 2022   1.51%
Amortizable mortgage advances  7,902   December 2017 to October 2021   1.78%
 $59,902       

 

Putable advances are callable at the option of the FHLB on a quarterly basis.

- 107 -

 

Estimated future minimum payments by fiscal year based on maturity date and current interest rates are as follows (In Thousands):

 

2017 $32,306 
2018  24,853 
2019  15,637  $45,926 
2020  21,283   21,563 
2021  10,143   15,307 
2022  219 
2023  3,169 
Thereafter  3,162   563 
Total minimum payments  107,384   86,747 
Less amounts representing interest  (3,441)  (1,534)
Less fair value adj. on acquired balances  (24)
Totals $103,943  $85,189 

 

First Defiance also utilizes short-term advances from the FHLB to meet cash flow needs and for short-term investment purposes. First Defiance borrows short-term advances under a variety of programs at FHLB. At December 31, 20162018 and 2015,2017, there were no amounts outstanding under First Defiance’s Cash Management Advance line of credit. The total available under this line is $15.0 million. In addition, First Defiance has a $100.0 million REPO Advance line of credit available. Twenty-five million was drawn on this line at December 31, 2018. There were no borrowings against this line at December 31, 2016 and 2015.2017. Amounts are generally borrowed under the Cash Management and REPO lines on an overnight basis.

 

13. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trust

 

In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (“Trust Affiliate II”) that issued $15 million of Guaranteed Capital Trust Securities (Trust Preferred Securities). In connection with the transaction, the Company issued $15.5 million of Junior Subordinated Deferrable Interest Debentures (“Subordinated Debentures”) to Trust Affiliate II. The Company formed Trust Affiliate II for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Subordinated Debentures held by Trust Affiliate II are the sole assets of that trust. The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Distributions on the Trust Preferred Securities issued by Trust Affiliate II are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.5%. The Coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate II was 2.46%4.29% and 2.01%3.09% as of December 31, 20162018 and 20152017, respectively.

- 103 -

 

The Trust Preferred Securities issued by Trust Affiliate II are subject to mandatory redemption, in whole or part, upon repayment of the Subordinated Debentures. The Company has entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on June 15, 2037, but can be redeemed at the Company’s option at any time now.

 

The Company also sponsors an affiliated trust, First Defiance Statutory Trust I (“Trust Affiliate I”), that issued $20 million of Trust Preferred Securities in 2005. In connection with this transaction, the Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Junior Debentures held by Trust Affiliate I are the sole assets of the trust. The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Distributions on the Trust Preferred Securities issued by Trust Affiliate I are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.38%. The Coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate I was 2.34%4.17% and 1.89%2.97% as of December 31, 20162018 and 20152017, respectively.

- 108 -

 

The Trust Preferred Securities issued by Trust Affiliate I are subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures. The Company has entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on December 15, 2035, but can be redeemed at the Company’s option at any time now.

 

The subordinated debentures may be included in Tier 1 capital (with certain limitations applicable) under current regulatory guidelines and interpretations.

 

A summary of all junior subordinated debentures issued by the Company to affiliates follows. These amounts represent the par value of the obligations owed to these affiliates, including the Company’s equity interest in the trusts. Junior subordinated debentures owed to the following affiliates were as follows:

 

 December 31  December 31, 
 2016  2015  2018  2017 
 (In Thousands)  (In Thousands) 
First Defiance Statutory Trust I due December 2035 $20,619  $20,619  $20,619  $20,619 
First Defiance Statutory Trust II due June 2037  15,464   15,464   15,464   15,464 
Total junior subordinated debentures owed to unconsolidated subsidiary Trusts $36,083  $36,083  $36,083  $36,083 

 

Interest on both issues of Trust Preferred Securities may be deferred for a period of up to five years at the option of the issuer.

 

- 104 -

14. Securities Sold Under Agreements to Repurchase and Other Short Term Borrowings

 

Total securities sold under agreement to repurchase are summarized as follows:

 

 Years Ended December 31  Years Ended December 31, 
 2016  2015  2018  2017 
 (In Thousands, Except Percentages)  (In Thousands, Except Percentages) 
Securities sold under agreement to repurchase                
Amounts outstanding at year-end $31,816  $57,188  $5,741  $26,019 
Year-end interest rate  0.22%  0.27%  0.31%  0.20%
Average daily balance during year  52,821   54,632   8,911   23,337 
Maximum month-end balance during the year  57,984   60,272   18,259   26,019 
Average interest rate during the year  0.26%  0.28%  0.26%  0.23%

 

We utilize securities sold under agreements to repurchase to facilitate the needs of our customers and to facilitate secured short-term funding needs. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. We monitor levels on a continuous basis. We may be required to provide additional collateral based on the fair value of the underlying securities. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agent.

 

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The remaining contractual maturity of the securities sold under agreements to repurchase in the consolidated balance sheets as of December 31, 20162018 and 20152017, is presented in the following tables.

 

 Overnight and
Continuous
  Up to 30
Days
  30-90 Days  Greater
than 90
Days
  Total  

 

Overnight and
Continuous

  Up to 30
Days
  30-90 Days  Greater
than 90
Days
  

 

 

Total

 
   (In Thousands) 
At December 31, 2016           
At December 31, 2018   (In Thousands) 
Repurchase agreements:                                        
Mortgage-backed securities – residential $21,222  $-  $-  $-  $21,222  $4,199  $-  $-  $-  $4,199 
Collateralized mortgage obligations  10,594   -   -   -   10,594   1,542   -   -   -   1,542 
Total borrowings $31,816  $-  $-  $-  $31,816  $5,741  $-  $-  $-  $5,741 
Gross amount of recognized liabilities for repurchase agreements                 $31,816                  $5,741 

 

  

Overnight and
Continuous

  Up to 30
Days
  30-90 Days  Greater
than 90
Days
  Total 
     (In Thousands) 
At December 31, 2015                    
Repurchase agreements:                    
Mortgage-backed securities – residential $23,998  $-  $-  $-  $23,998 
Collateralized mortgage obligations  33,190   -   -   -   33,190 
Total borrowings $57,188  $-  $-  $-  $57,188 
Gross amount of recognized liabilities for repurchase agreements                 $57,188 

On December 29, 2016, First Defiance entered into a loan agreement with First Tennessee Bank for a $20 million line of credit. The rate on the line of credit is at three- month LIBOR and was undrawn on as of December 31, 2016.

  

 

Overnight and
Continuous

  Up to 30
Days
  30-90 Days  Greater
than 90
Days
  

 

 

Total

 
At December 31, 2017    (In Thousands) 
Repurchase agreements:                    
Mortgage-backed securities – residential $6,599  $-  $-  $-  $6,599 
Collateralized mortgage obligations  19,420   -   -   -   19,420 
Total borrowings $26,019  $-  $-  $-  $26,019 
Gross amount of recognized liabilities for repurchase agreements                 $26,019 

 

As of December 31, 20162018 and 2015,2017, First Federal had the following undrawn lines of credit facilities available for short-term borrowing purposes:

A $20.0 million line of credit with First Tennessee Bank. The rate on the line of credit is at three- month LIBOR, which floats quarterly. This line was undrawn upon as of December 31, 2018 and 2017.

 

A $11.2 million line of credit with the Federal Reserve Bank Discount Window, at an interest rate of 50 basis points over the fedfederal funds rate. The fed funds rate as of December, 31, 20162018, was 0.75%2.25%. This line was undrawn upon as of December 31, 20162018 and 2015.2017.

- 105 -

 

A $20.0 million line of credit with MUFG Union Bank, N.A. The rate on this line of credit is Union Bank’s fedfederal funds rate, which floats daily. This line was undrawn upon as of December 31, 20162018 and 2015.2017.

 

15. Other Noninterest Expense

 

The following is a summary of other noninterest expense:

 

 Years Ended December 31  Years Ended December 31, 
 2016  2015 2014  2018  2017 2016 
 (In Thousands)  (In Thousands) 
Legal and other professional fees $2,902  $3,359  $3,622  $3,328  $3,603  $2,902 
Marketing  1,835   1,752   1,820   2,407   2,070   1,835 
State financial institutions tax  1,781   1,783   1,762   2,118   1,819   1,781 
REO expenses and write-downs  244   1,064   743 
OREO expenses and write-downs  742   177   244 
Printing and office supplies  512   457   466   631   626   512 
Amortization of intangibles  535   699   1,102   1,312   1,289   535 
Postage  456   459   594   505   523   456 
Check charge-offs and fraud losses  266   207   142   415   277   266 
Credit and collection expense  303   334   395   379   359   303 
Other  7,118(1)  5,402   6,611(2)  6,792(1)  8,067(2)  7,118(3)
Total other noninterest expense $15,952  $15,516  $17,257  $18,629  $18,810  $15,952 

- 110 -

 

1)Includes a credit of $806,000 for an accounting correction related to the Deferred Compensation Plan. See Note 19 for further details.
2)Includes $1.1 million of acquisition related expenses.
3)Includes $443,000 of acquisition related expenses and $300,000 of costs associated with termination of a lease agreement.
2)Includes $786,000 of costs associated with the termination of First Federal’s merger agreement with FCB.

 

16. Postretirement Benefits

 

First Defiance sponsors a defined benefit postretirement plan that is intended to supplement Medicare coverage for certain retirees who meet minimum age requirements. First Federal employees who retired prior to April 1, 1997, and who completed 20 years of service after age 40 receive full medical coverage at no cost. First Federal employees retiring after April 1, 1997, are provided medical benefits at a cost based on their combined age and years of service at retirement. Surviving spouses are also eligible for continued coverage after the retiree is deceased at a subsidy level that is 10% less than what the retiree is eligible for. First Federal employees retiring before July 1, 1997, receive dental and vision care in addition to medical coverage. First Federal employees who retire after July 1, 1997, are not eligible for dental or vision care.

 

First Federal employees who were born after December 31, 1950, are not eligible for the medical coverage described above at retirement. Rather, a one-time medical spending account of up to $10,000 (based on the participant’s age and years of service) will be established to reimburse medical expenses for those individuals. First Insurance employees who were born before December 31, 1950, can continue coverage until they reach age 65, or in lieu of continuing coverage, can elect the medical spending account option, subject to eligibility requirements. Employees hired or acquired after January 1, 2003, are eligible only for the medical spending account option.

 

Included in accumulated other comprehensive income at December 31, 2016, 20152018, 2017 and 20142016, are the following amounts that have not yet been recognized in net periodic benefit cost:

 

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 December 31  December 31, 
 2016  2015 2014  2018  2017 2016 
 (In Thousands)  (In Thousands) 
Unrecognized prior service cost $52  $53  $65  $97  $39  $52 
Unrecognized actuarial losses  392   593   832   (86)  551   392 
Total recognized in Accumulated Other Comprehensive Income  444   646   897 
Total loss recognized in Accumulated Other
Comprehensive Income
  11   590   444 
Income tax effect  (155)  (226)  (314)  80   (206)  (155)
Net amount recognized in Accumulated Other Comprehensive Income $289  $420  $583 
Net loss recognized in Accumulated Other
Comprehensive Income
 $91  $384  $289 

 

The prior service cost and actuarial loss included in other comprehensive income and expected to be recognized in net postretirement benefit cost during the fiscal year-ended December 31, 20172019, is $12,000$14,000 ($8,00011,000 net of tax) and $10,000 ($7,000 net of tax),$0, respectively.

 

Reconciliation of Funded Status and Accumulated Benefit Obligation

The plan is not currently funded. The following table summarizes benefit obligation and plan asset activity for the plan measured as of December 31 each year:

 

  December 31 
  2016  2015 
  (In Thousands) 
Change in benefit obligation:        
Benefit obligation at beginning of year $3,115  $3,263 
Service cost  53   65 
Interest cost  128   130 
Participant contribution  29   27 
Plan amendments for acquisitions  12   - 
Actuarial  (gains) / losses  (184)  (204)
Benefits paid  (168)  (166)
Benefit obligation at end of year  2,985   3,115 
Change in fair value of plan assets:        
Balance at beginning of year  -   - 
Employer contribution  139   139 
Participant contribution  29   27 
Benefits paid  (168)  (166)
Balance at end of year  -   - 
Funded status at end of year $(2,985) $(3,115)
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  December 31, 
  2018  2017 
  (In Thousands) 
Change in benefit obligation:        
Benefit obligation at beginning of year $3,194  $2,985 
Service cost  55   58 
Interest cost  105   117 
Participant contribution  32   29 
Plan amendments for acquisitions  72   - 
Actuarial (gains) / losses  (632)  166 
Benefits paid  (184)  (161)
Benefit obligation at end of year  2,642   3,194 
Change in fair value of plan assets:        
Balance at beginning of year  -   - 
Employer contribution  152   132 
Participant contribution  32   29 
Benefits paid  (184)  (161)
Balance at end of year  -   - 
Funded status at end of year $(2,642) $(3,194)

 

Net periodic postretirement benefit cost includes the following components:

 

  Years Ended December 31 
  2016  2015  2014 
  (In Thousands) 
Service cost-benefits attributable to service during the period $53  $65  $63 
Interest cost on accumulated postretirement benefit obligation  128   130   136 
Net amortization and deferral  30   47   35 
Net periodic postretirement benefit cost  211   242   234 
Net (gain) / loss during the year  (184)  (204)  377 
Plan amendment for acquisition  12   -   - 
Amortization of prior service cost and actuarial losses  (30)  (47)  (35)
Total recognized in comprehensive income  (202)  (251)  342 
Total recognized in net periodic postretirement benefit
cost and other comprehensive income
 $9  $(9) $576 

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  Years Ended December 31, 
  2018  2017  2016 
  (In Thousands) 
Service cost-benefits attributable to service during the period $55  $58  $53 
Interest cost on accumulated postretirement benefit obligation  105   117   128 
Net amortization and deferral  18   19   30 
Net periodic postretirement benefit cost  178   194   211 
Net (gain) / loss during the year  (632)  166   (184)
Plan amendment for acquisition  72   -   12 
Amortization of prior service cost and actuarial losses  (18)  (19)  (30)
Total recognized in comprehensive income  (578)  147   (202)
Total recognized in net periodic postretirement benefit
cost and other comprehensive income
 $(400) $341  $9 

 

The following assumptions were used in determining the components of the postretirement benefit obligation:

 

 2016  2015  2014  2018  2017 2016 
Weighted average discount rates:                        
Used to determine benefit obligations at December 31  4.00%  4.25%  4.25%  4.00%  3.50%  4.00%
Used to determine net periodic postretirement benefit cost for years ended December 31  4.25%  4.25%  4.75%  3.50%  4.00%  4.25%
                        
Assumed health care cost trend rates at December 31:                        
Health care cost trend rate assumed for next year  7.50%  6.50%  7.00%  6.50%  7.00%  7.50%
Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)  5.00%  5.00%  5.00%  3.90%  5.00%  5.00%
Year that rate reaches ultimate trend rate  2022   2019   2019   2075   2022   2022 

 

The following benefits are expected to be paid over the next five years and in aggregate for the next five years thereafter. Because the plan is unfunded, the expected net benefits to be paid and the estimated Company contributions are the same amount.

 

 Expected to be Paid  Expected to be Paid 
 (In Thousands)  (In Thousands) 
    
2017 $160 
2018  173 
2019  182  $168 
2020  197   181 
2021  180   195 
2022 through 2026  1,035 
2022  209 
2023  181 
2024 through 2028  969 


Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effect:

 

  One-Percentage-Point
Increase
  One-Percentage-Point
Decrease
 
  Year Ended December 31  Year Ended December 31 
  2016  2015  2016  2015 
  (In Thousands) 
Effect on total of service and interest cost $27  $27  $(22) $(22)
Effect on postretirement benefit obligation  369   376   (314)  (320)
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  One-Percentage-Point
Increase
  One-Percentage-Point
Decrease
 
  Year Ended December 31,  Year Ended December 31, 
  2018  2017   2018  2017 
  (In Thousands) 
Effect on total of service and interest cost $22  $25  $(18) $(21)
Effect on postretirement benefit obligation  178   392   (153)  (333)

 

The Company expects to contribute $160,000$168,000 before reflecting expected Medicare retiree drug subsidy payments in 2017.2019.

 

17. Regulatory Matters

 

First Defiance and First Federal isare subject to minimum capital adequacy guidelines.Failureguidelines. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators, which could have a material impact on First Federal’sDefiance’s financial statements. Under capital adequacy guidelines, First Defiance and the regulatory framework for prompt corrective action, First Federal must maintain capital amounts in excess of specified minimum ratios based on quantitative measures of First Federal’stheir assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

 

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In July 2013, the Federal Reserve and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (commonly known as Basel III). Under the final rules, which began for the CompanyFirst Defiance and the BankFirst Federal on January 1, 2015, and are subject to a phase-in period through January 1, 2019, minimum requirements will increase for both quantity and quality of capital held by the CompanyFirst Defiance and the Bank.First Federal. The rules include a new minimum common equity Tier 1 capital to risk-weighted assets ratio (“CET1”) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), which effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance sheet exposures.

 

The following schedule presents First Defiance consolidated and First Federal’sfederal banking agencies have also established a system of “prompt corrective action” to resolve certain problems of undercapitalized banks. The regulatory capital ratios as of December 31, 2016 and 2015 (Dollars in Thousands):

December 31, 2016
  Actual  Minimum Required for
Adequately Capitalized
  Minimum Required for Well
Capitalized
 
  Amount  Ratio  Amount  Ratio(1)  Amount  Ratio 
                   
CET1 Capital (to Risk-Weighted Assets) (2)                        
Consolidated $234,809   10.45% $101,108   4.5%  N/A   N/A 
First Federal $242,928   10.81% $101,116   4.5% $146,057   6.5%
                         
Tier 1 Capital (1)                        
Consolidated $269,809   11.24% $95,975   4.0%  N/A   N/A 
First Federal $242,928   10.14% $95,791   4.0% $119,739   5.0%
                         
Tier 1 Capital (to Risk Weighted Assets) (1)                        
Consolidated $269,809   12.01% $134,811   6.0%  N/A   N/A 
First Federal $242,928   10.81% $134,822   6.0% $179,763   8.0%
                         
Total Capital (to Risk Weighted Assets) (1)                        
Consolidated $295,693   13.16% $179,748   8.0%  N/A   N/A 
First Federal $268,812   11.96% $179,763   8.0% $224,703   10.0%

(1)Excludes capital conservation buffer of 0.625% as of December 31, 2016.
(2)Core capital is computed as a percentage of adjusted total assets of $2.40 billion for consolidated and $2.39 billion for the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.25 billion for consolidated and the Bank.

December 31, 2015
  Actual  Minimum Required for Adequately Capitalized  Minimum Required for Well Capitalized 
  Amount  Ratio  Amount  Ratio  Amount  Ratio 
                   
CET1 Capital (to Risk-Weighted Assets) (1)                        
Consolidated $218,297   10.71% $91,710   4.5%  N/A   N/A 
First Federal $236,625   11.61% $91,678   4.5% $132,424   6.5%
                         
Tier 1 Capital (1)                        
Consolidated $253,297   11.46% $88,424   4.0%  N/A   N/A 
First Federal $236,625   10.72% $88,267   4.0% $110,334   5.0%
                         
Tier 1 Capital (to Risk Weighted Assets) (1)                        
Consolidated $253,297   12.43% $122,280   6.0%  N/A   N/A 
First Federal $236,625   11.61% $122,237   6.0% $162,983   8.0%
                         
Total Capital (to Risk Weighted Assets) (1)                        
Consolidated $278,679   13.67% $163,040   8.0%  N/A   N/A 
First Federal $262,007   12.86% $162,983   8.0% $203,729   10.0%

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(1)Core capital is computed as a percentage of adjusted total assets of $2.21 billion for consolidated and the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.04 billion for consolidated and the Bank.

Management believes that, as of December, 31, 2016, First Federal was “well capitalized” based on the ratios presented above. There are no conditions or events since the most recent notification from any of the regulatory agencies regarding those capital standards that management believes have changed any of the well capitalized categorizations of First Federal.

First Federal is subject to the regulatory capital requirements administered by the OCC and FDIC. Regulatory authorities can initiate certain mandatory actions if First Federal fails to meet the minimum capital requirements, which could have a direct material effect on the Corporation’sFirst Defiance’s financial statements. Management believes,

The following schedule presents First Defiance consolidated and First Federal’s regulatory capital ratios as of December 31, 2016, that First Federal meets all capital adequacy requirements to which they are subject.2018 and 2017 (Dollars in Thousands):

 

December 31, 2018
  Actual  Minimum Required for
Adequately Capitalized
  Minimum Required to be Well
Capitalized for Prompt
Corrective Action
 
  Amount  Ratio  Amount  Ratio(1)  Amount  Ratio 
CET1 Capital (to Risk-Weighted Assets) (2)
Consolidated $303,860   11.00% $124,339   4.5%  N/A   N/A 
First Federal $322,520   11.68% $124,225   4.5% $179,436   6.5%
                         
Tier 1 Capital (2)                        
Consolidated $338,860   11.14% $121,716   4.0% ��N/A   N/A 
First Federal $322,520   10.62% $121,461   4.0% $151,827   5.0%
                         
Tier 1 Capital (to Risk Weighted Assets) (2)
Consolidated $338,860   12.26% $165,786   6.0%  N/A   N/A 
First Federal $322,520   11.68% $165,633   6.0% $220,844   8.0%
                         
Total Capital (to Risk Weighted Assets) (2)
Consolidated $367,191   13.29% $221,048   8.0%  N/A   N/A 
First Federal $350,851   12.71% $220,844   8.0% $276,055   10.0%

First Defiance is a unitary thrift holding company and is regulated by the Federal Reserve. First Defiance did not have prompt corrective action capital requirements as of December 31, 2016.

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(1)Excludes capital conservation buffer of 1.875% as of December 31, 2018.
(2)Core capital is computed as a percentage of adjusted total assets of $3.04 billion for consolidated and for the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.76 billion for consolidated and for the Bank.

 

December 31, 2017
  Actual  Minimum Required for
Adequately Capitalized
  Minimum Required to be Well
Capitalized for Prompt
Corrective Action
 
  Amount  Ratio  Amount  Ratio(1)  Amount  Ratio 
CET1 Capital (to Risk-Weighted Assets) (2)
Consolidated $274,832   10.43% $118,596   4.5%  N/A   N/A 
First Federal $298,571   11.33% $118,534   4.5% $171,216   6.5%
                         
Tier 1 Capital (2)                        
Consolidated $309,832   10.80% $114,773   4.0%  N/A   N/A 
First Federal $298,571   10.43% $114,539   4.0% $143,173   5.0%
                         
Tier 1 Capital (to Risk Weighted Assets) (2)
Consolidated $309,832   11.76% $158,128   6.0%  N/A   N/A 
First Federal $298,571   11.33% $158,046   6.0% $210,728   8.0%
                         
Total Capital (to Risk Weighted Assets) (2)
Consolidated $336,515   12.77% $210,838   8.0%  N/A   N/A 
First Federal $325,254   12,.35% $210,728   8.0% $263,410   10.0%

(1)Excludes capital conservation buffer of 1.25% as of December 31, 2017.
(2)Core capital is computed as a percentage of adjusted total assets of $2.87 billion for consolidated and $2.86 billion for the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.64 billion for consolidated and $2.63 billion for the Bank.

Dividend Restrictions -Dividends paid by First Federal to First Defiance are subject to various regulatory restrictions. First Federal paid $22.0 million in dividends to First Defiance in 20162018 and $29.0$13.0 million in 2015.2017. First Federal can initiate dividend payments equalmay not pay dividends to First Defiance in excess of its net profits (as defined by statute) for the last two fiscal years, plus any year to date net profits.profits without the approval of the OCC. First Insurance paid $1.2$1.6 million in dividends to First Defiance in 20162018 and $900,000$1.8 million in dividends in 2015.2017. First Defiance Risk Management paid $1.0 million$950,000 in dividends to First Defiance in 20162018 and 2015.$1.0 million in 2017.

 

18. Income Taxes

Income tax expense for 2017 was impacted by the adjustment of our deferred tax assets and liabilities related to the reduction in the U.S. federal statutory income tax rate to 21% under the Tax Cuts and Jobs Act, which was enacted on December 22, 2017. As a result of the new law, which is more fully discussed below, the Company recognized a net tax expense of $154,000.

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The components of income tax expense are as follows:

 

 Years Ended December 31  Years Ended December 31, 
 2016  2015 2014  2018  2017 2016 
 (In Thousands)  (In Thousands) 
Current:                        
Federal $13,125  $11,299  $9,198  $9,538  $14,588  $13,125 
State and local  244   146   144   207   181   244 
Deferred  (615)  (35)  (179)  881   1,261   (615)
Tax reform revaluation  -   154   - 
 $12,754  $11,410  $9,163  $10,626  $16,184  $12,754 

 

The effective tax rates differ from federal statutory rate applied to income before income taxes due to the following:

 

  Years Ended December 31 
  2016  2015  2014 
  (In Thousands) 
Tax expense at statutory rate (35%) $14,559  $13,240  $11,709 
Increases (decreases) in taxes from:            
State income tax – net of federal tax benefit  159   95   94 
Tax exempt interest income, net of TEFRA  (1,168)  (1,219)  (1,152)
Bank owned life insurance  (341)  (255)  (816)
Captive insurance  (414)  (415)  (390)
Other  (41)  (36)  (282)
Totals $12,754  $11,410  $9,163 

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  Years Ended December 31, 
  2018  2017  2016 
  (In Thousands) 
Tax expense at statutory rate (21%-2018 35%-2017 and 2016) $11,944  $16,958  $14,559 
Increases (decreases) in taxes from:            
State income tax – net of federal tax benefit  164   119   159 
Tax exempt interest income, net of TEFRA  (770)  (1,218)  (1,168)
Bank owned life insurance  (255)  (1,212)  (341)
Captive insurance  (325)  (364)  (414)
BOLI surrender  -   1,721   - 
Tax reform revaluation  -   154   - 
Other  (132)  26   (41)
Totals $10,626  $16,184  $12,754 

 

Deferred federal income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

 

Significant components of First Defiance’s deferred federal income tax assets and liabilities are as follows:

 

 December 31  December 31, 
 2016  2015  2018  2017 
 (In Thousands)  (In Thousands) 
Deferred federal income tax assets:                
Allowance for loan losses $9,059  $8,884  $5,802  $5,415 
Postretirement benefit costs  1,044   1,316   473   671 
Deferred compensation  1,847   1,621   1,011   1,354 
Impaired loans  1,087   261   1,154   1,432 
Accrued vacation  454   644   11   123 
Allowance for real estate held for sale losses  226   269   62   71 
Deferred loan origination fees and costs  462   388   435   332 
Accrued bonus ��626   675   638   333 
Net unrealized gains on available-for-sale securities  547   - 
Other  1,554   794   1,273   1,578 
Total deferred federal income tax assets  16,359   14,852   11,406   11,309 
                
Deferred federal income tax liabilities:                
FHLB stock dividends  2,279   2,279   1,558   1,558 
Goodwill  5,967   5,527   4,584   4,377 
Mortgage servicing rights  3,358   3,237   2,125   2,060 
Fixed assets  1,217   1,268   2,046   1,039 
Other intangible assets  301   422   778   990 
Loan mark to market  59   165   7   5 
Net unrealized gains on available-for-sale securities  272   2,176   -   194 
Prepaid expenses  694   655   550   539 
Other  22   316 
Total deferred federal income tax liabilities  14,147   15,729   11,670   11,078 
Net deferred federal income tax asset/ (liability) $2,212  $(877) $(264) $231 

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The realization of the Company’s deferred tax assets is dependent upon the Company’s ability to generate taxable income in future periods and the reversal of deferred tax liabilities during the same period and the ability to carryback any losses.period. The Company has evaluated the available evidence supporting the realization of its deferred tax assets and determined it is more likely than not that the assets will be realized and thus no valuation allowance was required at December 31, 2016.2018.

 

Retained earnings at December 31, 20162018, include approximately $11.0 million for which no tax provision for federal income taxes has been made. This amount represents the tax bad debt reserve at December 31, 1987, which is the end of the Company’s base year for purposes of calculating the bad debt deduction for tax purposes. If this portion of retained earnings is used in the future for any purpose other than to absorb bad debts, the amount used will be added to future taxable income. The unrecorded deferred tax liability on the above amount at December 31, 20162018, was approximately $3.85$2.31 million.

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A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (In Thousands):

 

Balance at January 1, 2014 $- 
Additions based on tax positions related to the current year  - 
Additions for tax positions of prior years  - 
Reductions for tax positions of prior years  - 
Reductions due to the statute of limitations  - 
Settlements  - 
Balance at December 31, 2014 $- 
    
Balance at January 1, 2015 $- 
Additions based on tax positions related to the current year  - 
Additions for tax positions of prior years  - 
Reductions for tax positions of prior years  - 
Reductions due to the statute of limitations  - 
Settlements  - 
Balance at December 31, 2015 $- 
    
Balance at January 1, 2016 $-  $- 
Additions based on tax positions related to the current year  -   - 
Additions for tax positions of prior years  398   398 
Reductions for tax positions of prior years  -   - 
Reductions due to the statute of limitations  -   - 
Settlements  -   - 
Balance at December 31, 2016 $398  $398 
    
Balance at January 1, 2017 $398 
Additions based on tax positions related to the current year  - 
Additions for tax positions of prior years  - 
Reductions for tax positions of prior years  - 
Reductions due to the statute of limitations  - 
Settlements  (398)
Balance at December 31, 2017 $- 
    
Balance at January 1, 2018 $- 
Additions based on tax positions related to the current year  - 
Additions for tax positions of prior years  - 
Reductions for tax positions of prior years  - 
Reductions due to the statute of limitations  - 
Settlements  - 
Balance at December 31, 2018 $- 

 

The Company does not expect the unrecognized tax benefits, to have an effect on its effective tax rate. The Company expects the entire amount of unrecognized tax benefits to settle within the next twelve months. The Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

 

The total amount of interest and penalties recorded in the income statement was $0, $0 and $40,000 for the yearyears ended December 31, 2016,2018, 2017 and zero for 2015 and 2014, and the2016. The amount accrued for interest and penalties was $0, $0 and $40,000 at December 31, 2016,2018, 2017 and zero for 2015 and 2014.2016.

 

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Indiana. The Company is no longer subject to examination by taxing authorities for years before 2012.2014. The Company currently operates primarily in the states of Ohio and Michigan, which tax financial institutions based on their equity rather than their income.

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Tax Cuts and Jobs Act –The Tax Cuts and Jobs Act was enacted on December 22, 2017. Among other things, the new law (i) established a new, flat corporate federal statutory income tax rate of 21%, (ii) eliminated the corporate alternative minimum tax and allowed the use of any such carryforwards to offset regular tax liability for any taxable year, (iii) limited the deduction for net interest expense incurrent by U.S. corporations, (iv) allowed businesses to immediately expense, for tax purposes, the cost of new investments in certain qualified depreciable assets, (v) eliminated or reduced certain deductions related to meals and entertainment expenses, (vi) modified the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee and (vii) limited the deductibility of deposit insurance premiums. The Tax Cuts and Jobs Act also significantly changed U.S. tax law related to foreign operations, however, such changes did not impact First Defiance.

As stated above, as a result of the enactment of the Tax Cuts and Jobs Act on December 22, 2017, First Defiance re-measured its deferred tax assets and liabilities based upon the newly enacted U.S. statutory federal income tax rate of 21%, which is the tax rate at which these assets and liabilities are expected to reverse in the future. First Defiance recognized a net tax expense related to the re-measurement of its deferred tax assets and liabilities totaling $154,000 as of December 31, 2017.

 

19. Employee Benefit Plans

 

401(k) Plan

 

Employees of First Defiance are eligible to participate in the First Defiance Financial Corp. 401(k) Employee Savings Plan (the “First Defiance 401(k)”) if they meet certain age and service requirements. Under the First Defiance 401(k), First Defiance matches 100% of the participants’ contributions up to 3% of compensation and then 50% of the participants’ contributions for the next 2% of compensation. The First Defiance 401(k) also provides for a discretionary First Defiance contribution in addition to the First Defiance matching contribution. First Defiance matching contributions totaled $979,000, $892,000$1.31 million, $1.19 million and $919,000$979,000 for the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively. There were no discretionary contributions in any of those years.

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Group Life Plan

 

On June 30, 2010, First Federal adopted the First Federal Bank of the Midwest Executive Group Life Plan – Post Separation (the “Group Life Plan”) in which various employees, including the Company’s named executive officers, may participate. Under the terms of the Group Life Plan, First Federal will purchase and own life insurance policies covering the lives of employees selected by the board of directors of First Federal as participants. There was $71,000, $78,000$38,000, $248,000 and $167,000$71,000 of expense recorded for the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively, with a liability of $1.04$1.71 million $970,000 and $892,000$1.69 million for future benefits recorded at December 31, 2016, 20152018 and 2014,2017, respectively. The acquisition of CSB added $402,000 to this liability in 2017. The discount rate was reduced to 4.00% as of December 31, 2016, resulting in an increase to the Company’s liability.liability, and remained unchanged at December 31, 2018.

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Deferred Compensation

The deferred compensation plan covers all directors and certain employees that elect to participate. Under the plan, the Company pays each participant, or their beneficiary, the amount of fees deferred plus interest over a defined time period. In the fourth quarter of 2018, the stock market declined significantly resulting in a significant decline in the value of the assets and liabilities of the deferred compensation plan and an accounting correction in the deferred compensation plan was recognized. The deferred compensation plan has approximately $5.0 million in assets and liabilities as of December 31, 2018, which are matched in terms of investment elections. Every year, other noninterest income and other noninterest expense reflects the changes in fair value of the underlying investments in the assets and liabilities, respectively. The Company made an accounting correction, which is expected to minimize any net impact to earnings from the deferred compensation plan going forward. This accounting correction was deemed immaterial which resulted in a one-time reduction to other noninterest expense of $806,000, including a $636,000 adjustment to equity for the phantom stock elections within the plan, and a $170,000 adjustment for the tax liability, as of December 31, 2018. The phantom shares are carried at cost in equity and will be treated as outstanding shares for earnings per share calculations.The net expense (income) recorded for the deferred compensation plan, excluding the one-time accounting correction, for each of the last three years was $15,000, $427,000 and $528,000 in 2018, 2017 and 2016, respectively, resulting in a deferred compensation liability of $4.5 million and $6.1 million as of year-end 2018 and 2017, respectively.

 

20.       Stock Compensation Plans

 

First Defiance has established equity based compensation plans for its directors and employees. On March 15, 2010,February 27, 2018, the Board adopted, and the shareholders approved at the 20102018 Annual Shareholders Meeting, the First Defiance Financial Corp. 20102018 Equity Incentive Plan (the “2010“2018 Equity Plan”). The 20102018 Equity Plan replaced all existing plans, existingalthough the Company’s former equity plans remain in existence to the extent there were outstanding grants thereunder at the time of its approval.the 2018 Equity Plan was approved. All awards currently outstanding under prior plans will remain in effect in accordance with their respective terms. Any new awards arewill be made under the 20102018 Equity Plan. The 20102018 Equity Plan allows for issuance of up to 350,000900,000 common shares through the award of options, stock grants, restricted stock units (“RSU”), stock appreciation rights or other stock-based awards.

 

As of December 31, 2016, 54,7502018, 39,400 options had been granted pursuant to the 2010 Equity Plan and previous plans, and remain outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Options granted under all plans vest 20% per year except for the 2009 grant to the Company’s executive officers, which vested 40% in 2011 and then 20% annually.year. All options expire ten years from the date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or three months after the retirement date.

 

In each of the years 2014-2016, theThe Company approved a Short-Term (“STIP”) Equity Incentive Plan and a Long-Term (“LTIP”) Equity Incentive Plan for selected members of management.

 

Under the 20142017 and 20152018 STIPs, the participants could earn up to 30% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The 2016 STIP allows participants to earn up to 10% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The final amount of benefits under the STIPs is determined as of December 31 of the same year and paid out in cash in the first quarter of the following year. The participants are required to be employed on the day of payout in order to receive such payment.

 

Under each LTIP, the participants may earn up tobetween 20% to 45% of their salary for potential payout in the form of equity awards based on the achievement of certain corporate performance targets over a three-year period. The Company granted 30,538; 24,757;49,052, 41,314 and 24,52641,676 RSU’s to the participants in the 2014, 20152016, 2017 and 20162018 LTIPs, respectively, effective January 1 in the year the award was made, which represents the maximum target award. The amount of benefit under each LTIP will be determined individually at the end of the 36 month performance period ending December 31. The benefits earned under each LTIP will be paid out in equity in the first quarter following the end of the performance period. The participants are required to be employed on the day of payout in order to receive suchthe payment.

 

 - 113118 - 

 

 

A total of 49,514 RSU’s were issued to the participants of the 2015 LTIP in the first quarter of 2018 for the three year performance period ended December 31, 2017.

In 2016,2018, the Company also granted 3,894to employees 23,952 restricted shares, to directorsof which 7,348 were RSUs and employees. 1,872 shares16,604 were restricted stock grants. Of the 16,604 restricted stock grants, 4,104 were issued to directors 1,000 sharesand have a one-year vesting period. The remaining 12,500 were issued to employees thatand have a one-year vesting period and 1,022 shares were issued to an employee with a fourthree year vesting period. The fair value of all granted restricted shares was determined by the stock price at the date of the grant.

 

The fair value of each option award is estimated on the date of grant using the Black-Scholes model. Expected volatilities are based on historical volatilities of the Company’s common shares. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

 

The fair value of stockThere were no options granted was determined atduring the date of grant using the Black-Scholes stock option-pricing model and the following assumptions:twelve months ended December 31, 2018, or December 31, 2017.

  Twelve Months Ended
  December 31,
2016
 December 31,
 2015
Expected average risk-free rate 2.05% 2.04%
Expected average life 8.96 years 10.00 years
Expected volatility 41.00% 42.00%
Expected dividend yield 2.33% 2.10%

 

Following is activity under the plans during 2016:2018:

 

Stock options: Options
Outstanding
  Weighted
Average
Exercise Price
  Weighted
Average
Remaining
Contractual
Term (in years)
  Aggregate
Intrinsic
Value
(in 000’s)
 
Options outstanding, January 1, 2016  86,220  $20.27         
Forfeited or cancelled  -   -         
Exercised  (37,970)  20.47         
Granted  6,500   37.78         
Options outstanding, December 31, 2016  54,750  $22.21   3.51  $1,562 
Vested or expected to vest at December 31, 2016  54,750  $22.21   3.51  $1,562 
Exercisable at December 31, 2016  38,300  $17.86   1.57  $1,259 
  Options
Outstanding
  Weighted
Average
Exercise Price
  Weighted
Average
Remaining
Contractual
Term (in years)
  Aggregate
Intrinsic
Value
(in 000’s)
 
Options outstanding, January 1, 2018  86,900  $10.81         
Forfeited or cancelled  -   -         
Exercised  (47,500)  8.15         
Granted  -   -         
Options outstanding, December 31, 2018  39,400  $14.00   4.96  $414 
Vested or expected to vest at December 31, 2018  39,400  $14.00   4.96  $414 
Exercisable at December 31, 2018  23,900  $12.21   4.14  $294 

 

Information related to the stock option plans is as follows:

 

  Year Ended December 31 
  2016  2015  2014 
  (In Thousands, except per share amounts) 
Intrinsic value of options exercised $752  $1,069  $542 
Cash received from option exercises  714   1,469   963 
Tax benefit realized from option exercises  165   160   103 
Weighted average fair value of options granted $13.95  $13.13  $10.79 

- 114 -

  Year Ended December 31, 
  2018  2017  2016 
  (In Thousands, except per share amounts) 
Intrinsic value of options exercised $893  $301  $752 
Cash received from option exercises  111   198   714 
Tax benefit realized from option exercises  28   54   165 
Weighted average fair value of options granted $-  $-  $13.95 

 

As of December 31, 2016,2018, there was $156,000$50,000 of total unrecognized compensation costs related to unvested stock options granted under the Company’s equity plans. The cost is expected to be recognized over a weighted-average period of 3.21.6 years.

 

At December 31, 2016, 75,468 RSU’s2018, 174,958 restricted share awards were outstanding. Compensation expense is recognized over the performance period based on the achievement of established targets. Total expense of $1.3$2.0 million, $1.1$2.0 million and $541,000$1.3 million was recorded during the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively, and approximately $773,000$961,000 and $556,000$774,000 is included within other liabilities at December 31, 20162018 and 2015,2017, respectively, related to the STIPs and LTIPs.

 

  Restricted Stock Units  Stock Grants 
     Weighted-Average     Weighted-Average 
     Grant Date     Grant Date 
Unvested Shares Shares  Fair Value  Shares  Fair Value 
             
Unvested at January 1, 2016  74,545  $25.86   10,927  $30.98 
Granted  24,526   39.30   10,905   23.39 
Vested  (7,011)  19.19   (10,171)  24.02 
Forfeited  (16,592)  19.19   (500)  32.00 
Unvested at December 31, 2016  75,468  $32.31   11,161  $32.30 
- 119 -

  Restricted Stock Units  Stock Grants 
     Weighted-Average     Weighted-Average 
     Grant Date     Grant Date 
Unvested Shares Shares  Fair Value  Shares  Fair Value 
             
Unvested at January 1, 2018  145,076  $20.26   21,072  $25.28 
Granted  49,024   26.97   66,118   19.68 
Vested  (49,514)  16.15   (56,818)  17.51 
Forfeited  -   -   -   - 
Unvested at December 31, 2018  144,586  $23.94   30,372  $28.48 

 

The maximum amount of compensation expense that may be earned for the 20162018 STIP and the 2014, 20152016, 2017 and 20162018 LTIPs at December 31, 20162018, is approximately $3.6$4.3 million in the aggregate. However, the estimated expense expected to be earned as of December 31, 20162018, based on the performance measures in the plans, is $2.4$3.7 million of which $584,000$899,000 was unrecognized at December 31, 20162018, and will be recognized over the remaining performance period.

 

As of December 31, 2016 and 2015, 168,251 and 186,0792018, 895,500 shares respectively, were available for grant under the 20102018 Equity Plan. Options forfeited or cancelled under all plans except the 20102018 Equity PlanPlans are no longer available for grant to other participants.

 

21. Parent Company Statements

 

Condensed parent company financial statements, which include transactions with subsidiaries, are as follow:

  December 31, 
Statements of Financial Condition 2018  2017 
  (In Thousands) 
Assets        
Cash and cash equivalents $12,153  $8,860 
Investment in banking subsidiary  398,922   377,546 
Investment in non-bank subsidiaries  23,372   22,319 
Other assets  1,723   1,157 
Total assets $436,170  $409,882 
         
Liabilities and stockholders’ equity:        
Subordinated debentures $36,083  $36,083 
Accrued liabilities  498   513 
Stockholders’ equity  399,589   373,286 
Total liabilities and stockholders’ equity $436,170  $409,882 

 

  December 31 
Statements of Financial Condition 2016  2015 
  (In Thousands) 
Assets        
Cash and cash equivalents $23,017  $12,919 
Investment in banking subsidiary  290,053   287,436 
Investment in non-bank subsidiaries  15,456   15,109 
Other assets  1,155   1,191 
Total assets $329,681  $316,655 
         
Liabilities and stockholders’ equity:        
Subordinated debentures $36,083  $36,083 
Accrued liabilities  580   375 
Stockholders’ equity  293,018   280,197 
Total liabilities and stockholders’ equity $329,681  $316,655 
  Years Ended December 31, 
Statements of Income 2018  2017  2016 
  (In Thousands) 
          
Dividends from subsidiaries $24,550  $15,800  $24,200 
Interest expense  (1,281)  (1,090)  (753)
Other income  1   1   - 
Noninterest expense  (831)  (697)  (644)
Income before income taxes and equity in earnings of subsidiaries  22,439   14,014   22,803 
Income tax credit  (431)  (605)  (466)
Income before equity in earnings of subsidiaries  22,870   14,619   23,269 
Undistributed equity in earnings of subsidiaries  23,379   17,649   5,574 
Net income  46,249   32,268   28,843 
Other comprehensive income (loss)  (2,412)  2   (3,407)
Comprehensive income $43,837  $32,270  $25,436 
             

 

 - 115120 - 

 

 

  Years Ended December 31 
Statements of Income 2016  2015  2014 
  (In Thousands) 
          
Dividends from subsidiaries $24,200  $30,900  $22,200 
Interest on investments  -   1   - 
Interest expense  (753)  (613)  (587)
Other income  -   1   2 
Noninterest expense  (644)  (588)  (861)
Income before income taxes and equity in earnings of subsidiaries  22,803   29,701   20,754 
Income tax credit  (466)  (397)  (485)
Income before equity in earnings of subsidiaries  23,269   30,098   21,239 
(Distributions in excess of) undistributed equity in earnings of subsidiaries  5,574   (3,675)  3,053 
Net income $28,843  $26,423  $24,292 
Comprehensive income $25,436  $25,931  $27,861 

 Years Ended December 31  Years Ended December 31, 
Statements of Cash Flows 2016  2015 2014  2018  2017 2016 
 (In Thousands)  (In Thousands) 
Operating activities:                        
Net income $28,843  $26,423  $24,292  $46,249  $32,268  $28,843 
Adjustments to reconcile net income to net cash (used in) provided by operating activities:                        
Distribution in excess of (undistributed equity in) earnings of subsidiaries  (5,574)  3,675   (3,053)
Undistributed equity in earnings of subsidiaries  (23,379)  (17,649)  (5,574)
Change in other assets and liabilities  235   (205)  59   (419)  (358)  235 
Net cash provided by (used in) operating activities  23,504   29,893   21,298   22,451   14,261   23,504 
            
Investing activities:            
Cash paid for Commercial Bancshares  -   (12,340)  - 
Capital contribution to subsidiary  -   (6,491)  - 
Net cash used in investing activities  -   (18,831)  - 
                        
Financing activities:                        
Repurchase of common stock  (6,293)  (8,436)  (15,519)  (6,330)  -   (6,293)
Cash dividends paid  (7,890)  (7,159)  (5,937)  (13,043)  (9,859)  (7,890)
Stock Options Exercised  714   1,469   921   111   199   714 
Direct stock sales  63   64   76   104   73   66 
Repayment of stock warrants  -   (11,979)  - 
Net cash used in financing activities  (13,406)  (26,041)  (20,459)  (19,158)  (9,587)  (13,406)
Net increase (decrease) in cash and cash equivalents  10,098   3,852   839   3,293   (14,157)  10,098 
Cash and cash equivalents at beginning of year  12,919   9,067   8,228   8,860   23,017   12,919 
Cash and cash equivalents at end of year $23,017  $12,919  $9,067  $12,153  $8,860  $23,017 

 

22. Fair Value

 

FASB ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

 

 - 116121 - 

 

 

FASB ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on the best information available. In that regard, FASB ASC Topic 820 established a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

·Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

·Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by a correlation or other means.

 

·Level 3: Unobservable inputs for determining fair value of assets and liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

 

Available for sale securities - Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs where the Company obtains fair value measurements from an independent pricing service that uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. Securities in Level 1 include federal agency preferred stock securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities, corporate bonds and municipal securities.

 

Impaired loans -Fair values for impaired collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure.  Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach.  The cost method bases value on the cost to replace the current property.  Value of market comparison approach evaluates the sales price of similar properties in the same market area.  The income approach considers net operating income generated by the property and an investors required return.  Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available.  Comparable sales adjustments are based on known sales prices of similar type and similar use properties and duration of time that the property has been on the market to sell.  Such adjustments made in the appraisal process are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

 - 117122 - 

 

 

Real Estate held for sale- Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are then reviewed monthly by members of the asset review committee for valuation changes and are accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which may utilize a single valuation approach or a combination of approaches including cost, comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value.

 

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company.  Once received, a member of the Company’s asset quality or collections department reviews the assumptions and approaches utilized in the appraisal.  Appraisal values are discounted from 0% to 20% to account for other factors that may impact the value of collateral. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used, which include:  physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

 

Mortgage servicing rights – On a quarterly basis, mortgage servicing rights are evaluated for impairment based upon the fair value of the rights as compared to the carrying amount. If the carrying amount of an individual tranche exceeds fair value, impairment is recorded on that tranche so that the servicing asset is carried at fair value. Fair value is determined at a tranche level based on a model that calculates the present value of estimated future net servicing income. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and are validated against available market data (Level 2).

 

Mortgage banking derivative - The fair value of mortgage banking derivatives are evaluated monthly based on derivative valuation models using quoted prices for similar assets adjusted for specific attributes of the commitments and other observable market data at the valuation date (Level 2).

 

The following table summarizes the financial assets measured at fair value on a recurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

- 118 -

Assets and Liabilities Measured on a Recurring Basis

 

December 31, 2016 Level 1
Inputs
  Level 2
Inputs
  Level 3
Inputs
  Total Fair
Value
 
December 31, 2018 

 

Level 1
Inputs

 

 

Level 2
Inputs

 

 

Level 3
Inputs

 

 

Total Fair
Value

 
 (In Thousands)  (In Thousands) 
Available for sale securities:                                
                
Obligations of U.S. Government corporations and agencies $-  $3,915  $-  $3,915  $-  $2,503  $-  $2,503 
Mortgage-backed - residential  -   81,707   -   81,707   -   74,710   -   74,710 
REMICs  -   1,307   -   1,307   -   2,709   -   2,709 
Collateralized mortgage obligations  -   63,005   -   63,005   -   101,461   -   101,461 
Preferred stock  2   -   -   2   -   -   -   - 
Corporate bonds  -   13,013   -   13,013   -   12,806   -   12,806 
Obligations of state and political subdivisions  -   88,043       88,043   -   99,887       99,887 
Mortgage banking derivative - asset  -   491   -   491   -   367   -   367 
Mortgage banking derivative -liability  -   73   -   73 

 

December 31, 2015 Level 1
Inputs
  Level 2
Inputs
  Level 3
Inputs
  Total Fair
Value
 
        (In Thousands)    
Available for sale securities:                
                 
Obligations of U.S. Government corporations and agencies $-  $2,994  $-  $2,994 
Mortgage-backed - residential  -   64,654   -   64,654 
REMICs  -   1,620   -   1,620 
Collateralized mortgage obligations  -   71,799   -   71,799 
Preferred stock  1   -   -   1 
Corporate bonds  -   4,977   -   4,977 
Obligations of state and political subdivisions  -   90,390       90,390 
Mortgage banking derivative - asset  -   558   -   558 
- 123 -

December 31, 2017 

 

Level 1
Inputs

  

 

Level 2
Inputs

  

 

Level 3
Inputs

  

 

Total Fair
Value

 
  (In Thousands) 
Available for sale securities:                
Obligations of U.S. Government corporations and agencies $-  $508  $-  $508 
Mortgage-backed - residential  -   59,269   -   59,269 
REMICs  -   1,065   -   1,065 
Collateralized mortgage obligations  -   93,876   -   93,876 
Preferred stock  1   -   -   1 
Corporate bonds  -   13,103   -   13,103 
Obligations of state and political subdivisions  -   92,828       92,828 
Mortgage banking derivative - asset  -   609   -   609 
Mortgage banking derivative -liability  -   11   -   11 

 

There were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 20162018 and 2015.2017.

 

The following table summarizes the financial assets measured at fair value on a non-recurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

- 119 -

Assets and Liabilities Measured on a Non-Recurring Basis

 

December 31, 2016 Level 1 Inputs  Level 2 Inputs  Level 3 Inputs  Total Fair
Value
 

December 31, 2018

 

 

Level 1 Inputs

 

 

Level 2 Inputs

 

 

Level 3 Inputs

  Total Fair
Value
 
 (In Thousands)  (In Thousands) 
Impaired loans                                
1-4 Family Residential Real Estate $-  $-  $316  $316 
Multi Family Residential  -   -   -   - 
Commercial Real Estate  -   -   848   848  $-  $-  $1,456  $1,456 
Commercial          332   332           319   319 
Home Equity and Improvement  -   -   -   - 
Total impaired loans  -   -   1,496   1,496   -   -   1,775   1,775 
                                
Mortgage servicing rights  -   657   -   657   -   629   -   629 
                
Real estate held for sale                                
Residential  -   -   -   - 
CRE  -   -   377   377   -   -   705   705 
Total Real Estate held for sale  -   -   377   377   -   -   705   705 

 

December 31, 2015 Level 1 Inputs  Level 2 Inputs  Level 3 Inputs  Total Fair
Value
 
  (In Thousands) 
Impaired loans                
1-4 Family Residential Real Estate $-  $-  $398  $398 
Multi Family Residential  -   -   91   91 
Commercial Real Estate  -   -   4,575   4,575 
Commercial          -   - 
Home Equity and Improvement  -   -   82   82 
Total impaired loans  -   -   5,146   5,146 
                 
Mortgage servicing rights  -   872   -   872 
Real estate held for sale                
Residential  -   -   -   - 
CRE  -   -   280   280 
Total Real Estate held for sale  -   -   280   280 

- 124 -

 

December 31, 2017

 

 

Level 1 Inputs

  

 

Level 2 Inputs

  

 

Level 3 Inputs

  Total Fair
Value
 
  (In Thousands) 
Impaired loans                
Commercial Real Estate $-  $-  $1,787  $1,787 
Commercial          2,817   2,817 
Total impaired loans  -   -   4,604   4,604 
                 
Mortgage servicing rights  -   534   -   534 
                 
Real estate held for sale                
CRE  -   -   227   227 
Total Real Estate held for sale  -   -   227   227 

 

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2016,2018, the significant unobservable inputs used in the fair value measurements were as follows:

 

- 120 -

 Fair
Value
  Valuation Technique Unobservable Inputs Range of
Inputs
  Weighted
Average
  

 

Fair

Value

 

 

 

Valuation Technique

 

 

 

Unobservable Inputs

 

 

Range of
Inputs

 

 

Weighted
Average

 
    (Dollars in Thousands)    (Dollars in Thousands)
                      
Impaired Loans- Applies to all loan classes $1,496  Appraisals which utilize sales comparison, net income and cost approach Discounts for collection issues and changes in market conditions      10-30%  11% $1,775  Appraisals which utilize sales comparison, net income and cost approach Discounts for collection issues and changes in market conditions   10-13%  10.86%
                              
Real estate held for sale – Applies to all classes $377  Appraisals which utilize sales comparison, net income and cost approach Discounts for changes in market conditions   0-20%  7% $705  Appraisals which utilize sales comparison, net income and cost approach Discounts for changes in market conditions  20%  20%

 

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2015,2017, the significant unobservable inputs used in the fair value measurements were as follows:

 

 Fair
Value
 Valuation Technique Unobservable Inputs Range of
Inputs
 Weighted
Average
  

 

Fair

Value

 

 

 

Valuation Technique

 

 

 

Unobservable Inputs

 

 

Range of
Inputs

  

 

Weighted
Average

 
   (Dollars in Thousands)    (Dollars in Thousands)
                       
Impaired Loans- Applies to all loan classes $5,146  Appraisals which utilize sales comparison, net income and cost approach Discounts for collection issues and changes in market conditions    10-30%  11% $4,604  Appraisals which utilize sales comparison, net income and cost approach Discounts for collection issues and changes in market conditions   10-20%  11%
                              
Real estate held for sale – CRE $280  Appraisals which utilize sales comparison, net income and cost approach Discounts for changes in market conditions  30%  30%
Real estate held for sale – Applies to all classes $227  Appraisals which utilize sales comparison, net income and cost approach Discounts for changes in market conditions  0%  0%

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $1.5 million, with a $1,000 valuation allowance and a fair value of $5.1$1.8 million, with a valuation allowance of $8,000$9,000 and a fair value of $4.6 million with no valuation allowance at December 31, 20162018 and 2015,2017, respectively. A provision expense of $1.0$1.2 million, a provision recovery of $580,000 and a provision expense of $3.0$993,000, $1.0 million for the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively, related to these impaired loans was included in earnings.

- 125 -

 

Mortgage servicing rights, which are carried at the lower of cost or fair value, had a fair value of $657,000$629,000 with a valuation allowance of $522,000$300,000 and a fair value of $872,000$534,000 with a valuation allowance of $645,000$432,000 at December 31, 20162018 and 2015,2017, respectively. A recovery of $123,000, $266,000$132,000, $90,000 and $116,000$123,000 for the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively, was included in earnings.

 

Real estate held for sale is determined using Level 3 inputs which include appraisals and are adjusted for changes in market conditions. The change in fair value of real estate held for sale was $74,000, $297,000$552,000, $20,000 and $251,000$74,000 for the years ended December 31, 2016, 20152018, 2017 and 2014,2016, respectively, which was recorded directly as an adjustment to current earnings through non-interestnoninterest expense.

 

In accordance with FASB ASC Topic 825, the Fair Value Measurements tables are a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of December 31, 20162018, and December 31, 2015.2017. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.

- 121 -

 

Much of the information used to arrive at “fair value” is highly subjective and judgmental in nature and therefore the results may not be precise. Subjective factors include, among other things, estimated cash flows, risk characteristics and interest rates, all of which are subject to change. With the exception of investment securities, the Company’s financial instruments are not readily marketable and market prices do not exist. Since negotiated prices for the instruments, which are not readily marketable, depend greatly on the motivation of the buyer and seller, the amounts that will actually be realized or paid per settlement or maturity of these instruments could be significantly different.

 

The carrying amount of cash and cash equivalents, term notes payable and advance payments by borrowers for taxes and insurance, as a result of their short-term nature, is considered to be equal to fair value and are classified as Level 1.

 

It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

 

The Company adopted the amendments to ASU 2016-01 relating to the loan portfolio in 2018 and an exit price income approach is now used to determine the fair valuevalue. The loans were valued on an individual basis, with consideration given to the loans underlying characteristics, including account types, remaining terms (in months), annual interest rates or coupons, interest types, past delinquencies, timing of loans that reprice within 90 days is equal to their carrying amount. For other loans, the estimated fair value is calculated based onprincipal and interest payments, current market rates, loss exposures, and remaining balances. The model utilizes a discounted cash flow analysis, using interest rates currently being offered for loans with similar terms, resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as previously described. The allowance for loan losses is considered to be a reasonable adjustment for credit risk. The methods utilizedapproach to estimate the fair value of the loans do not necessarily representusing assumptions for the coupon rates, remaining maturities, prepayment speeds, projected default probabilities, losses given defaults, and estimates of prevailing discount rates. The discounted cash flow approach models the credit losses directly in the projected cash flows. The model applies various assumptions regarding credit, interest, and prepayment risks for the loans based on loan types, payment types and fixed or variable classifications. As of December 31, 2017, the fair value was estimated by discounting the future cash flows using the rates at which similar notes would be written for the same remaining maturities or an exit price.entry price income approach. The market rates used were based on current rates the Company would impose for similar loans and reflect a market participant assumption about risks associated with non-performance, illiquidity, and the structure and term of the loans along with local economic and market conditions. For all periods presented, the estimated fair value of impaired loans held for sale is estimated based on binding contracts and quotes from third party investors resulting in athe fair value of the collateral, less estimated cost to sell, or the present value of the loan’s expected future cash flows (discounted at the loan’s effective interest rate). All impaired loans are classified as Level 2 classification.3 within the valuation hierarchy.

 

The fair value of accrued interest receivable is equal to the carrying amounts resulting in a Level 2 or Level 3 classification, which is consistent with its underlying asset.

 

- 126 -

The fair value of non-interest bearingnoninterest-bearing deposits are considered equal to the amount payable on demand at the reporting date (i.e., carrying value) and are classified as Level 1. The fair value of savings, NOW and certain money market accounts are equal to their carrying amounts and are a Level 2 classification. Fair values of fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

 

The fair values of securities sold under repurchase agreements are equal to their carrying amounts resulting in a Level 2 classification. The carrying value of subordinated debentures and deposits with fixed maturities is estimated based on discounted cash flow analyses based on interest rates currently being offered on instruments with similar characteristics and maturities resulting in a Level 3 classification.

 

FHLB advances with maturities greater than 90 days are valued based on discounted cash flow analysis, using interest rates currently being quoted for similar characteristics and maturities resulting in a Level 2 classification. The cost or value of any call or put options is based on the estimated cost to settle the option at December 31, 2016.2018.

     Fair Value Measurements at December 31, 2018
(In Thousands)
 
  Carrying Value  Total  Level 1  Level 2  Level 3 
Financial Assets:                    
Cash and cash equivalents $98,962  $98,962  $98,962  $-  $- 
Investment securities  294,602   294,602   -   294,602   - 
FHLB Stock  14,217   N/A   N/A   N/A   N/A 
Loans, net, including loans
held for sale
  2,518,321   2,501,096   -   6,865   2,494,231 
Accrued interest receivable  9,641   9,641   18   1,168   8,455 
                     
Financial Liabilities:                    
Deposits $2,620,882  $2,613,965  $607,198  $2,006,767  $- 
Advances from FHLB  85,189   84,281   -   84,281   - 
Securities sold under repurchase agreements  5,741   5,741   -   5,741   - 
Subordinated debentures  36,083   28,854   -   -   28,854 

     Fair Value Measurements at December 31, 2017
(In Thousands)
 
  Carrying
Value
  Total  Level 1  Level 2  Level 3 
Financial Assets:                    
Cash and cash equivalents $113,693  $113,693  $113,693  $-  $- 
Investment securities  261,298   261,299   1   261,298   - 
FHLB Stock  15,992   N/A   N/A   N/A   N/A 
Loans, net, including loans
held for sale
  2,332,465   2,315,791   -   10,830   2,304,961 
Accrued interest receivable  8,706   8,706   13   917   7,776 
                     
Financial Liabilities:                    
Deposits $2,437,656  $2,444,683  $571,360  $1,873,323  $- 
Advances from FHLB  84,279   83,261   -   83,261   - 
Securities sold under repurchase agreements  26,019   26,019   -   26,019   - 
Subordinated debentures  36,083   35,385   -   -   35,385 

 

 - 122127 - 

 

     Fair Value Measurements at December 31, 2016
(In Thousands)
 
  Carrying
Value
  Total  Level 1  Level 2  Level 3 
Financial Assets:                    
Cash and cash equivalents $99,003  $99,003  $99,003  $-  $- 
Investment securities  251,176   251,179   2   251,177   - 
Federal Home Loan Bank Stock  13,798   N/A   N/A   N/A   N/A 
Loans, net, including loans held for sale  1,924,210   1,911,280   -   9,917   1,901,363 
Accrued interest receivable  6,760   6,760   9   867   5,884 
                     
Financial Liabilities:                    
Deposits $1,981,628  $1,987,723  $487,663  $1,500,060  $- 
Advances from Federal Home Loan Bank  103,943   103,019   -   103,019   - 
Securities sold under repurchase agreements  31,816   31,816   -   31,816   - 
Subordinated debentures  36,083   34,718   -   -   34,718 

     Fair Value Measurements at December 31, 2015
(In Thousands)
 
  Carrying
Value
  Total  Level 1  Level 2  Level 3 
Financial Assets:                    
Cash and cash equivalents $79,769  $79,769  $79,769  $-  $- 
Investment securities  236,678   236,680   1   236,679   - 
Federal Home Loan Bank Stock  13,801   N/A   N/A   N/A   N/A 
Loans, net, including loans held for sale  1,782,358   1,784,998   -   5,899   1,779,099 
Accrued interest receivable  6,171   6,171   7   846   5,318 
                     
Financial Liabilities:                    
Deposits $1,836,137  $1,840,464  $420,691  $1,419,773  $- 
Advances from Federal Home Loan Bank  59,902   59,653   -   59,653   - 
Securities sold under repurchase agreements  57,188   57,188   -   57,188   - 
Subordinated debentures  36,083   35,305   -   -   35,305 

 

23.Derivative Financial Instruments

 

Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of mortgage loans to third-party investors are considered derivatives. It is the Company’s practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from its commitments to fund the loans. These mortgage banking derivatives are not designated in hedge relationships. First Federal had approximately $14.1$8.6 million and $14.9$14.8 million of interest rate lock commitments at December 31, 20162018 and 2015,2017, respectively. There were $22.5$11.5 million and $19.9$23.2 million of forward commitments for the future delivery of residential mortgage loans at December 31, 20162018 and 2015,2017, respectively.

- 123 -

 

The fair value of these mortgage banking derivatives are reflected by a derivative asset or a derivative liability. The table below provides data about the carrying values of these derivative instruments:

 

 December 31, 2016 December 31, 2015  December 31, 2018 December 31, 2017 
 Assets (Liabilities)   Assets (Liabilities)    Assets (Liabilities)   Assets (Liabilities)   
     Derivative     Derivative      Derivative     Derivative 
 Carrying Carrying Net Carrying Carrying Carrying Net Carrying  Carrying Carrying Net Carrying Carrying Carrying Net Carrying 
 Value Value Value Value Value Value  Value Value Value Value Value Value 
 (In Thousands)  (In Thousands) 
Derivatives not designated as hedging instruments                                     
Mortgage Banking Derivatives $491  $-  $491  $558  $-  $558  $367  $73  $294  $609  $11  $598 

 

The table below provides data about the amount of gains and losses recognized in income on derivative instruments not designated as hedging instruments:

 

 Twelve Months Ended December 31,  Twelve Months Ended December 31, 
 2016  2015 2014  2018  2017 2016 
 (In Thousands)  (In Thousands) 
Derivatives not designated as hedging instruments                        
            
Mortgage Banking Derivatives – Gain (Loss) $(67) $231  $27  $(304) $107  $(67)

 

- 128 -

The above amounts are included in mortgage banking income with gain on sale of mortgage loans. During 2014, management determined that a group of loans, previously classified as held for sale, were no longer sellable and were transferred back into the portfolio. As a result, a $5,000 loss related to a fair value adjustment on those loans was recorded in. No such adjustments were made in 2016 or 2015.

 

24. Quarterly Consolidated Results of Operations (Unaudited)

 

The following is a summary of the quarterly consolidated results of operations:

 

 Three Months Ended  Three Months Ended 
 March 31  June 30  September 30  December 31  March 31  June 30  September 30  December 31 
 (In Thousands, Except Per Share Amounts)  (In Thousands, Except Per Share Amounts) 
2016                
2018   
Interest income $21,130  $21,480  $22,003  $22,770  $28,905  $30,299  $31,963  $33,550 
Interest expense  1,942   2,084   2,183   2,231   3,218   3,752   4,434   5,058 
Net interest income  19,188   19,396   19,820   20,539   25,687   26,547   27,529   28,492 
Provision for loan losses  364   53   15   (149)  (1,095)  423   1,376   472 
Net interest income after provision for loan losses  18,824   19,343   19,805   20,688   26,782   26,124   26,153   28,020 
Gain on sale, call or write-down of securities  131   227   151   -   -   -   76   97 
Noninterest income  8,505   8,348   8,375   8,293   10,703   10,214   9,846   8,272 
Noninterest expense  17,274   17,347   18,292   18,180   23,251   22,665   22,286   21,210 
Income before income taxes  10,186   10,571   10,039   10,801   14,234   13,673   13,789   15,179 
Income taxes  3,017   3,307   2,994   3,436   2,497   2,564   2,483   3,082 
Net income $7,169  $7,264  $7,045  $7,365  $11,737  $11,109  $11,306  $12,097 
                                
Earnings per common share:                                
Basic $0.80  $0.81  $0.78  $0.82  $0.58  $0.54  $0.55  $0.60 
Diluted $0.80  $0.80  $0.78  $0.81  $0.58  $0.54  $0.55  $0.59 
Average shares outstanding:                                
Basic  8,994   8,968   8,976   8,969   20,330   20,388   20,400   20,313 
Diluted  9,064   9,036   9,050   9,035   20,438   20,492   20,467   20,404 

 

- 124 -

 Three Months Ended  Three Months Ended 
 March 31 June 30 September 30 December 31  March 31 June 30 September 30 December 31 
 (In Thousands, Except Per Share Amounts)  (In Thousands, Except Per Share Amounts) 
2015                
2017   
Interest income $19,757  $20,037  $20,266  $20,776  $24,036  $27,458  $28,081  $28,527 
Interest expense  1,567   1,672   1,733   1,809   2,391   2,826   3,074   3,140 
Net interest income  18,190   18,365   18,533   18,967   21,645   24,632   25,007   25,387 
Provision for loan losses  120   -   (27)  43   55   2,118   462   314 
Net interest income after provision for loan losses  18,070   18,365   18,560   18,924   21,590   22,514   24,545   25,073 
Gain on sale, call or write-down of securities  -   -   -   22   -   267   158   159 
Noninterest income  8,281   7,809   7,982   7,709   10,549   9,873   9,337   9,738 
Noninterest expense  16,897   16,796   16,848   17,348   23,142   20,630   20,440   21,139 
Income before income taxes  9,454   9,378   9,694   9,307   8,997   12,024   13,600   13,831 
Income taxes  2,853   2,815   2,998   2,744   3,857   3,677   4,219   4,431 
Net income $6,601  $6,563  $6,696  $6,563  $5,140  $8,347  $9,381  $9,400 
                                
Earnings per common share:                                
Basic $0.71  $0.71  $0.72  $0.72  $0.27  $0.41  $0.46  $0.47 
Diluted $0.69  $0.70  $0.72  $0.71  $0.27  $0.41  $0.46  $0.46 
Average shares outstanding:                                
Basic ��9,234   9,268   9,238   9,146   18,870   20,294   20,298   20,310 
Diluted  9,611   9,349   9,322   9,235   18,980   20,408   20,418   20,444 

 

25. Other Comprehensive Income (Loss)

 

The before and after tax amounts allocated to each component of other comprehensive income (loss) are presented in the table below. Reclassification adjustments related to securities available for sale are included in gains on sale or call of securities in the accompanying consolidated condensed statements of income. Reclassification adjustments related to the defined benefit postretirement medical plan are included in compensation and benefits in the accompanying consolidated condensed statements of income.

  Before Tax
Amount
  Tax Expense
(Benefit)
  Net of Tax
Amount
 
  (In Thousands) 
Twelve months ended December 31, 2016:            
Securities available for sale and transferred securities:            
Change in net unrealized gain/(loss) during the period $(4,933) $(1,726) $(3,207)
Reclassification adjustment for net gains included in net income  (509)  (178)  (331)
Defined benefit postretirement medical plan:            
Net gain on defined benefit postretirement medical plan realized during the period  172   60   112 
Reclassification adjustment for net amortization and deferral on defined benefit postretirement medical plan (included in compensation and benefits)  30   11   19 
Total other comprehensive income $(5,240) $(1,833) $(3,407)

 - 125129 - 

 

 

  Before Tax
Amount
  Tax Expense
(Benefit)
  Net of Tax
Amount
 
  (In Thousands) 
Twelve months ended December 31, 2015:            
Securities available for sale and transferred securities:            
Change in net unrealized gain/(loss) during the period $(985) $(345) $(640)
Reclassification adjustment for net gains included in net income  (22)  (7)  (15)
Defined benefit postretirement medical plan:            
Net gain on defined benefit postretirement medical plan realized during the period  204   72   132 
Reclassification adjustment for net amortization and deferral on defined benefit postretirement medical plan (included in compensation and benefits)  47   16   31 
Total other comprehensive income $(756) $(264) $(492)

  Before Tax
Amount
  Tax Effect  Net of Tax
Amount
 
  (In Thousands) 
Twelve months ended December 31, 2018:            
Securities available for sale and transferred securities:            
 Change in net unrealized gain/(loss) during the period $(3,356) $(706) $(2,650)
 Reclassification adjustment for net gains included in net income  (173)  (36)  (137)
Defined benefit postretirement medical plan:            
 Net gain on defined benefit postretirement medical plan realized during the period  560   200   360 
Reclassification adjustment for net amortization and deferral on defined benefit postretirement medical plan (included in compensation and benefits)  18   3   15 
Total other comprehensive income $(2,951) $(539) $(2,412)

  Before Tax
Amount
  Tax Effect  Net of Tax
Amount
 
  (In Thousands) 
Twelve months ended December 31, 2017:            
Securities available for sale and transferred securities:            
 Change in net unrealized gain/(loss) during the period $733  $256  $477 
 Reclassification adjustment for net gains included in net income  (584)  (204)  (380)
Defined benefit postretirement medical plan:            
 Net gain on defined benefit postretirement medical plan realized during the period  (166)  (59)  (107)
Reclassification adjustment for net amortization and deferral on defined benefit postretirement medical plan (included in compensation and benefits)  19   7   12 
Total other comprehensive income $2  $-  $2 

 

Activity in accumulated other comprehensive income (loss), net of tax, was as follows:

 

      Accumulated       Accumulated 
 Securities Post- Other  Securities Post- Other 
 Available retirement Comprehensive  Available retirement Comprehensive 
 For Sale  Benefit  Income  For Sale  Benefit  Income 
 (In Thousands)  (In Thousands) 
Balance January 1, 2016 $4,042  $(420) $3,622 
Balance January 1, 2018 $601  $(384) $217 
Other comprehensive income before reclassifications  (3,207)  112   (3,095)  (2,651)  360   (2,291)
Amounts reclassified from accumulated other comprehensive loss  (331)  19   (312)  (136)  15   (121)
                        
Net other comprehensive income during period  (3,538)  131   (3,407)  (2,787)  375   (2,412)
                        
Balance December 31, 2016 $504  $(289) $215 
Reclassification adjustment upon adoption of ASU 2018-02  129   (82)  47 
                        
Balance January 1, 2015 $4,697  $(583) $4,114 
Balance December 31, 2018 $(2,057) $(91) $(2,148)
            
            
Balance January 1, 2017 $504  $(289) $215 
Other comprehensive income before reclassifications  (640)  132   (508)  477   (108)  369 
Amounts reclassified from accumulated other comprehensive loss  (15)  31   16   (380)  13   (367)
                        
Net other comprehensive income during period  (655)  163   (492)  97   (95)  2 
                        
Balance December 31, 2015 $4,042  $(420) $3,622 
Balance December 31, 2017 $601  $(384) $217 

- 126 -

 

Item 9.Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

- 130 -

Item 9A.Controls and Procedures

 

First Defiance’s management carried out an evaluation, under the supervision and with the participation of the chief executive officer and the chief financial officer, of the effectiveness of First Defiance’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2016.2018. Based upon that evaluation, the chief executive officer along with the chief financial officer concluded that First Defiance’s disclosure controls and procedures as of December 31, 2016,2018, are effective.

 

The information set forth under “Management’s Report on Internal Control Over Financial Reporting” and “Report of Independent Registered Public Accounting Firm” included in Item 8 above is incorporated herein by reference.

 

There were no changes in First Defiance’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter ended December 31, 20162018, that have materially affected, or are reasonably likely to materially affect First Defiance’s internal control over financial reporting.

 

Item 9B.Other Information

 

On February 23, 2017, the Compensation Committee of First Defiance approved a new form of restricted stock unit (“RSU”) award agreement that may be used to grant RSUs pursuant to First Defiance’s 2010 Equity Plan. The form agreement provides for a grant of RSUs that vest on the third anniversary of the grant date and are settled in common shares of First Defiance. Vesting is accelerated in the event of death, disability or retirement (as defined under the 2010 Equity Plan). Vesting also is accelerated in the event of termination of employment without cause after a change in control (as defined under the 2010 Equity Plan). The form of award agreement contains a non-solicitation covenant. The form of RSU award agreement is attached as Exhibit 10.24 and incorporated herein by reference.

None.

 

PART III

 

Item 10.Directors, Executive Officers and Corporate Governance

 

The information required by this item relating to our directors, nominees for directorship and executive officers is incorporated herein by reference from the section captioned “Composition of the Board” under the heading “PROPOSAL 1 – Election of Directors” and the section immediately following the heading “EXECUTIVE OFFICERS” in the Company’s definitive proxy statement towhich will be filed on or about March 29, 2017 for the annual meeting of First Defiance shareholders to be held on May 9, 2017no later than 120 days after December 31, 2018 (the “Proxy Statement”). Information regarding our Audit Committee and compliance with Section 16(a) of the Securities Act of 1943 required by this item is incorporated herein by reference from the sections respectively captioned, “Board Committees” under the “Proposal“PROPOSAL 1 – Election of Directors” and the section immediately following the heading “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE” of the Proxy Statement. There have been no material changes to the procedures by which shareholders may recommend nominees to the board of directors.

 

First Defiance has adopted a code of ethics applicable to all officers, directors and employees that complies with SEC requirements, and is available on its Internet site atwww.fdef.com under the Governance Documents.Documents tab on the Investor Relations page.

 

Item 11.Executive Compensation

 

Information regarding director compensation is set forth under the section captioned “Director Compensation” under the heading “PROPOSAL 1 – Election of Directors” of the Proxy Statement, and is incorporated herein by reference. Executive compensation information has been provided under the headings “COMPENSATION DISCUSSION AND ANALYSIS” and “EXECUTIVE COMPENSATION” in the Proxy Statement, and is incorporated herein by reference.

 

- 127 -

The Compensation Committee Report and information related to compensation committee interlocks and insider participation have been respectively set forth under the section immediately following the heading “COMPENSATION COMMITTEE REPORT” and under the section captioned “Compensation Committee Interlocks and Insider Participation” following the heading “PROPOSAL 1 – Election of Directors” in the Proxy Statement, and are incorporated herein by reference.

 

- 131 -

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The information regarding security ownership of certain beneficial owners and management and information relating thereto is set forth in the section under the heading “BENEFICIAL OWNERSHIP” in the Proxy Statement, and is incorporated herein by reference.

 

Equity Compensation Plans

 

The following table provides information as of December 31, 20162018, with respect to the shares of First Defiance common stock that are reserved for issuance under First Defiance’s existing equity compensation plans.

 

Plan Category Number of securities to
be Issued Upon
Exercise of Outstanding
Options, Warrants and
Rights
 Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights
 Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column (a)
  

 

 

Number of securities to
be Issued Upon
Exercise of Outstanding
Options, Warrants and
Rights

 

 

 

Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights

 

 

Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column (a)

 
 (a) (b) (c)  (a) (b) (c) 
Equity Compensation Plans Approved by Security Holders  54,750  $22.21   168,251   39,400  $14.00   895,500 

 

Item 13.Certain Relationships and Related Transactions, and Director Independence

 

The information required by this item, including related transactions and director independence, is set forth respectively in the section following the heading “RELATED PERSON TRANSACTIONS” and in the section captioned “Composition of the Board” following the heading “PROPOSAL 1 – Election of Directors” in the Proxy Statement, which are both incorporated by reference.

 

Item 14.Principal Accountant Fees and Services

 

The information required by this item is set forth under the section captioned “Audit Fees” following the heading “INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM” in the Proxy Statement, and is incorporated herein by reference.

 

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PART IV

 

Item 15. Exhibits, Financial Statement Schedules

Item 15.Exhibits, Financial Statement Schedules

 

(a)Financial Statements

 

(1)The following documents are filed as Item 8 of this Form 10-K.

 

 (A)Report of Independent Registered Public Accounting Firm (Crowe Horwath LLP)
 

(B)

Consolidated Statements of Financial Condition as of December 31, 20162018 and 20152017

 

(C)

Consolidated Statements of Income for the years ended December 31, 2016, 20152018, 2017 and 20142016

 

(D)

Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 20152018, 2017 and 20142016
 

(E)

Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016, 20152018, 2017 and 20142016

 

(F)

Consolidated Statements of Cash Flows for the years ended December 31, 2016, 20152018, 2017 and 20142016

 (G)Notes to Consolidated Financial Statements

 

(2)Separate financial statement schedules are not being filed because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements or the related notes.

 

(3)The exhibits required by this item are listed in the Exhibit Index of this Form 10-K. The management contracts and compensation plans or arrangements required to be filed with this Form 10-K are listed as Exhibits 10.1 through 10.24.10.29.

Item 16.10-K Summary

None.

 

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SIGNATURES

 

Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrantregistrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 FIRST DEFIANCE FINANCIAL CORP.

February 28, 20172019By:/s/ Kevin T. Thompson
 
 Kevin T. Thompson, Chief Financial Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrantregistrant and in the capacities indicated on February 28, 2017.2019.

 

Signature Title
   
/s/ William J. SmallJohn L. Bookmyer Chairman of the Board
William J. SmallJohn L. Bookmyer  
   
/s/ Donald P. Hileman President and Chief
Donald P. Hileman 

Executive Officer

   
/s/ Kevin T. Thompson Executive Vice President and Chief
Kevin T. Thompson Financial Officer (principal accounting officer)
   
/s/ Stephen L. BoomerRobert E. Beach Director Vice Chairman
Stephen L. BoomerRobert E. Beach  
   
/s/ John L. BookmyerDouglas A. Burgei, D.V.M. Director
John L. Bookmyer
/s/ Dr. Douglas A. Burgei,Director
Dr. Douglas A. Burgei D.V.M.  
   
/s/ Thomas A. Reineke Director
Thomas A. Reineke  
   
/s/ BarbBarbara A. Mitzel Director
BarbBarbara A. Mitzel  
   
/s/ Jean A. Hubbard Director
Jean A. Hubbard  
   
/s/ Samuel S. Strausbaugh Director
Samuel S. Strausbaugh  
   
/s/ Charles D. Niehaus Director
Charles D. Niehaus  
/s/ Terri A. BettingerDirector
Terri A. Bettinger
/s/ Thomas K. HermanDirector

Thomas K. Herman

/s/ Mark A. RobisonDirector
Mark A. Robison

 - 130134 - 

 

 

Exhibit Index

 

This report incorporates by reference the documents listed below that we have previously filed with the SEC. The SEC allows us to incorporate by reference information in this document. The information incorporated by reference is considered to be part of this document.

 

This information may be read and copied at the Public Reference Room of the SEC at 100 F Street, N.E., Washington D.C. 20549. The SEC also maintains an internet web site that contains reports, proxy statements, and other information about issuers, like First Defiance, who file electronically with the SEC. The address of the site ishttp://www.sec.gov.www.sec.gov. The reports and other information filed by First Defiance with the SEC are also available at the First Defiance Financial Corp. web site. The address of the site ishttp://www.fdef.com.www.fdef.com. Except as specifically incorporated by reference into this Annual Report on Form 10-K, information on those web sites is not part of this report.

 

Exhibit    
Number Description  
2.1 Amendment to Agreement and Plan of Merger, dated August 23, 2016 by and between First Defiance and Commercial Bancshares, Inc. (29)
2.2 Amendment to Agreement and Plan of Merger, dated October 31, 2016 by and between First Defiance and Commercial Bancshares, Inc. (12)
3.1 Articles of Incorporation (1)
3.2 Code of Regulations (1)
3.3 Amendment to Articles of Incorporation (7)
4.1 Agreement to furnish instruments and agreements defining rights of holders of long-term debt (27)
4.2 Form of Warrant for Purchase of Shares of Common Stock (11)
10.1 Form of Stock Option Award Agreement under 2001 Stock Option and Incentive Plan (2)
10.2 2001 Stock Option and Incentive Plan (4)
10.3 Employment Agreement with Gregory R. Allen (5)
10.4 2005 Stock Option and Incentive Plan (6)
10.5 Letter Agreement, dated December 5, 2008, between First Defiance and the U.S. Treasury (8)
10.6 2008 Long Term Incentive Compensation Plan (LTIP) (9)
10.7 Form of Contingent Award Agreement under LTIP (10)
10.8 Form of Stock Option Award Agreement under 2005 Stock Option and Incentive Plan (3)
10.9 First Federal Amended and Restated Executive Group Life Plan – Post Separation (13)
10.10 2010 Equity Incentive Plan (14)
10.11 First Defiance Deferred Compensation Plan (22)
10.12 Form of Restricted Stock Award Agreement (with TARP Limitations) (15)
10.13 2010 Equity Plan Form of Long-Term Incentive Performance-Based Award Agreement (16)
10.14 2010 Equity Plan Form of Short-Term Incentive Performance-Based Award Agreement (17)
10.15 First Amendment to First Defiance Financial Corp. 2010 Equity Incentive Plan (18)
10.16 First Defiance Financial Corp. and Affiliates Incentive Compensation Plan (19)
10.17 First Defiance Financial Corp. Long-Term Restricted Stock Unit Award Agreement (2012 Long Term Incentive – TARP Applicable) (20)
10.18 First Defiance Financial Corp. Long-Term Restricted Stock Unit Award Agreement (2012 Long Term Incentive) (21)
10.19 Employment Agreement with Donald P. Hileman (23)
10.20 Employment Agreement with Kevin T. Thompson (24)
10.21 Form of Restricted Stock Award Agreement (25)
10.22 Consulting Agreement with William J. Small (26)
10.23 Change of Control and Non-Solicitation Agreement with John R. Reisner (28)
10.24 Form of Restricted Stock Unit Award Agreement (12)
21 List of Subsidiaries of the Company (12)
23.1 Consent of Crowe Horwath LLP (12)
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (12)
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (12)
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (12)
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (12)
101 Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to the Consolidated Financial Statements tagged as blocks of text and in detail. (12)

Exhibit  
NumberDescription 
2.1Agreement and Plan of Merger, dated August 23, 2016, by and between First Defiance and Commercial Bancshares, Inc.(28)
2.2Amendment to Agreement and Plan of Merger, dated October 31, 2016, by and between First Defiance and Commercial Bancshares, Inc.(12)
3.1Articles of Incorporation of First Defiance(1)
3.2Amendment to Articles of Incorporation of First Defiance(30)
3.3Code of Regulations of First Defiance(31)
4.1Agreement to furnish instruments and agreements defining rights of holders of long-term debt(26)
10.1Employment Agreement with Gregory R. Allen(5)
10.22005 Stock Option and Incentive Plan(6)
10.3Form of Stock Option Award Agreement under 2005 Stock Option and Incentive Plan(3)
10.4First Federal Amended and Restated Executive Group Life Plan – Post Separation(13)
10.52010 Equity Incentive Plan(14)
10.6First Amendment to First Defiance Financial Corp. 2010 Equity Incentive Plan(18)
10.72010 Equity Plan Form of Long-Term Incentive Performance-Based  Award Agreement(16)
10.82010 Equity Plan Form of Short-Term Incentive Performance-Based Award Agreement(17)
10.9Form of Restricted Stock Award Agreement under 2010 Equity Plan(25)
10.10Form of Restricted Stock Unit Award Agreement under 2010 Equity Plan(12)
10.11First Defiance Deferred Compensation Plan(22)
10.12First Defiance Financial Corp. and Affiliates Incentive Compensation Plan(19)
10.13First Defiance Financial Corp. Long-Term Restricted Stock Unit Award Agreement (2012 Long Term Incentive)(21)
10.14Employment Agreement with Donald P. Hileman(23)
10.15Employment Agreement with Kevin T. Thompson(24)
10.162014 Change of Control and Non-Solicitation Agreement with John R. Reisner(27)
10.17Change of Control Agreement and Non-Compete Agreement with Gregory R. Allen(32)
10.18First Amendment to Donald P. Hileman’s Employment Agreement(33)
10.19First Amendment to Kevin T. Thompson’s Employment Agreement(34)
10.20Form of Restricted Stock Award Agreement under 2018 Equity Incentive Plan(35)
10.21Form of Restricted Stock Unit Award Agreement under 2018 Equity Incentive Plan(36)
10.22First Defiance Deferred Compensation Plan, revised October 30, 2014(37)
10.232018 Change of Control and Non-Solicitation Agreement with John Reisner(38)
10.242018 Employment Agreement with Donald P. Hileman(39)
10.252018 Employment Agreement with Kevin T. Thompson(40)
10.26Form of Performance-Based Restricted Stock Unit Award Agreement (LTIP) under the 2018 Equity Incentive Plan(29)
10.27Form of Performance-Based Restricted Stock Unit Award Agreement (Long-Term Equity Asset Growth) under the 2018 Equity Incentive Plan(29)
10.28Form of Performance-Based Restricted Stock Unit Award Agreement (LTIP) under the 2010 Equity Incentive Plan(29)
10.29Form of Performance-Based Restricted Stock Unit Award Agreement (Long-Term Equity Asset Growth) under the 2010 Equity Incentive Plan(29)
21List of Subsidiaries of the Company(29)
23.1Consent of Crowe LLP(29)
31.1Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(29)
31.2Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(29)
32.1Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(29)
32.2Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(29)
101Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to the Consolidated Financial Statements tagged as blocks of text and in detail.  (29)

 

 - 131135 - 

 

 

(1)Incorporated herein by reference to the like numbered exhibit in the Registrant’s Form S-1S-3 filed on November 10, 2009 (File No. 33-93354)333-163014)
(2)Incorporated herein by reference to exhibitExhibit 10.2 in the Registrant’s 2004 Form 10-K (Film(File No. 05685500)000-26850)
(3)

Incorporated herein by reference to exhibitExhibit 10.16 in the Registrant’s 2008 Form 10-K (Film(File No. 09683948)000-26850)

(4)Incorporated herein by reference to Appendix B to the 2001 Proxy Statement (Film(File No. 1577137)000-26850)
(5)Incorporated herein by reference to exhibitExhibit 10.4 in Form 8-K filed October 1, 2007 (Film(File No. 071144951)000-26850)
(6)Incorporated herein by reference to Appendix A to the 2005 Proxy Statement (Film(File No. 05692264)000-26850)
(7)Incorporated herein by reference to exhibitExhibit 3 in Form 8-K filed December 8, 2008 (Film(F File No. 081236105)000-26850)
(8)Incorporated herein by reference to exhibitExhibit 10 in Form 8-K filed December 8, 2008 (Film(File No. 081236105)000-26850)
(9)Incorporated herein by reference to exhibitExhibit 10.1 in Form 8-K filed December 12, 2008 (Film(File No. 081245224)000-26850)
(10)Incorporated herein by reference to exhibit 10.2 in Form 8-K filed December 12, 2008 (Film No. 081245224)
(11)Incorporated herein by reference to exhibitExhibit 4 in Form 8-K filed December 8, 2008 (Film(File No. 081236105)000-26850)
(12)IncludedIncorporated herein by reference to Exhibit 10.24 in the Registrant’s 2016 Form 10-K (File No. 000-26850)
(13)Incorporated herein by reference to exhibitExhibit 10.1 in Form 10-Q filed November 2, 2010 (Film(File No. 101158262)000-26850)
(14)Incorporated herein by reference to Annex A to 2010 Proxy Statement (Film(File No. 10693151)000-26850)
(15)Incorporated herein by reference to exhibitExhibit 10.1 in Form 8-K filed March 4, 2011 (Film(File No. 11664601)000-26850)
(16)Incorporated herein by reference to exhibitExhibit 10.1 in Form 10-Q filed November 8, 2011 (Film(File No. 111188059)000-26850)
(17)Incorporated herein by reference to exhibitExhibit 10.2 in Form 10-Q filed November 8, 2011 (Film(File No. 111188059)000-26850)
(18)Incorporated herein by reference to exhibitExhibit 10.1 in Form 8-K filed March 15, 2012 (Film(File No. 12694926)000-26850)
(19)Incorporated herein by reference to exhibitExhibit 10.2 in Form 8-K filed March 15, 2012 (Film(File No. 12694926)000-26850)
(20)Incorporated herein by reference to exhibitExhibit 10.3 in Form 8-K filed March 15, 2012 (Film(File No. 12694926)000-26850)

- 136 -

(21)Incorporated herein by reference to exhibitExhibit 10.4 in Form 8-K filed March 15, 2012 (Film(File No. 12694926)000-26850)
(22)Incorporated herein by reference to exhibitExhibit 10.1 in Form 8-K filed December 23, 2005 (Film(File No. 051284175)000-26850)
(23)Incorporated herein by reference to exhibitExhibit 10.1 in Form 8-K filed December 30, 2013 (Film(File No. 131303552)000-26850)
(24)Incorporated herein by reference to exhibitExhibit 10.2 in Form 8-K filed December 30, 2013 (Film(File No. 131303552)000-26850)
(25)Incorporated herein by reference to exhibitExhibit 10.3 in Form 8-K filed December 30, 2013 (Film(File No. 131303552)000-26850)
(26)Incorporated herein by reference to exhibit 10.4Exhibit 4,1 in Registrant’s 2014 Form 8-K filed December 30, 2013 (Film10-K (File No. 131303552000-26850)
(27)Incorporated herein by reference to like numbered exhibitExhibit 10.23 in Registrant’s 20142015 Form 10-K (Film(File No. 15655545)000-26850)
(28)Incorporated herein by reference to exhibit 10.23 in Registrant’s 2015 Form 10-K (Film No. 161468309)
(29)Incorporated herein by reference to the like numbered exhibitExhibit 2.1 in Form 8-K filed August 24, 2016 (Film(File No. 161848221)000-26850)
(29)Included herein
(30)Incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on June 22, 2018 (File No. 000-26850).
(31)

Incorporated by reference to Exhibit 4.3 of the Registrant’s Form S-8 POS filed on July 17, 2018 (333-197203).

(32)Incorporated herein by reference to Exhibit 10.4 in Form 10-Q filed May 8, 2018 (File No. 000-26850)
(33)Incorporated herein by reference to Exhibit 10.1 in Form 8-K filed February 23, 2018 (File No. 000-26850)
(34)Incorporated herein by reference to Exhibit 10.2 in Form 8-K filed February 23, 2018 (File No. 000-26850)
(35)Incorporated herein by reference to Exhibit 10.1 in Form 10-Q filed August 7, 2018 (File No. 000-26850)
(36)Incorporated herein by reference to Exhibit 10.2 in Form 10-Q filed August 7, 2018 (File No. 000-26850)
(37)Incorporated herein by reference to Exhibit 10.3 in Form 10-Q filed August 7, 2018 (File No. 000-26850)
(38)Incorporated herein by reference to Exhibit 10.1 in Form 8-K filed March 22, 2018 (File No. 000-26850)
(39)Incorporated herein by reference to Exhibit 10.1 in Form 8-K filed December 27, 2018 (File No. 000-26850)
(40)Incorporated herein by reference to Exhibit 10.2 in Form 8-K filed December 27, 2018 (File No. 000-26850)

 

 - 132137 -